Borrowers beware

Written by Kumud Das | Sitanshu Swain | Updated: Jun 19 2011, 08:48am hrs
Girija Nayak, 38, a chartered accountant, took a home loan of R50 lakh in 2007 from ICICI Bank to buy a flat in Mumbais upmarket Chembur area. Today, Nayak is a hassled man. He had taken the loan at floating rate at a time when the rates in the country had peaked at 14-15 % as the Reserve Bank India (RBI) went on a rate raising spree from 2005 onwards to check surging inflation. However, Nayak didnt mind availing the loan at such a high rate as he was more concerned about the firming up of real estate prices, which had almost trebled between 2004 and 2007 in Mumbai.

When the ripples of the global financial crisis hit India, RBI had to reverse its tight monetary policy and adopt an expansionary one by providing liquidity support to the economy. Banks responded by slashing lending rates to spur demands in the system.

As Nayak had borrowed at floating rate, he was hoping that the interest rate on his home loan would also fall in keeping with the dip in the overall lending rates in the system. But it didnt. I got a relief of just 1-2% in interest rate and my home loan installment remained almost the same, rues Nayak.

In a tactical move, through a new platform called teaser home loan, those banks which refused to bring down the floating rates on existing home loans offered much cheaper rates to new home loan customers. Teaser home loans launched by State Bank of India, ICICI Bank, Punjab National Bank and HDFC offered new housing finance schemes with both fixed and floating rates.

For example, SBI for its new home loan set an invitation interest rate of 8% for the first year, 8.5% for the next and floating rates for the rest of the tenure. The scheme attracted attention and other banks and housing loan companies, too, followed suit. SBI succeeded in growing its retail housing loan portfolio aggressively and disbursed around R40,000 crore over two and half years under this scheme.

HDFC launched its dual rate scheme in December 2009 and offered loans at a fixed rate of 8.5% up to March 31, 2011, at 9.5 % for a period between April 1, 2011 and March 31, 2012 and the applicable floating rate for the balance term. It disbursed about R24,000 crore under the scheme in one year.

Though RBI criticised the teaser schemes openly, it couldnt do much to bring any relief to old borrowers. Banks refused to bring down the rates significantly, saying that their cost of the funds as evident in prevailing high deposit rates had not fallen.

While advanced economies continued with their ultra expansionary monetary policies and kept rates at the lowest, RBI, beginning 2010, started taking baby steps towards tighter monetary policy as it reset its priorities to curb a surging inflationary expectation.

In its latest policy, the central bank once again10th time since 2010opted for a hike of 25 basis points in key repo (the rate at which RBI lends to commercial banks) and reverse repo rates after a steep hike of 50 basis points in repo rate on May 3. With the latest increase, RBI has so far hiked 250 bps in policy rates since April 2010.

Banks and housing finance companies, which have always been quick to announce rate hike in their corporate and retail lending instruments, are bracing up to announce another round of hike in rates sooner or later, which is such bound to make life difficult for both old borrowers like Nayak, who are paying equated monthly installments (EMI) on floating interest rates, and new buyers.

MD Mallya, CMD, Bank of Baroda, says, The message is clear that the interest rates are set to go up. Home loans are likely to get affected, though slightly.

Agreeing with him, S Raman, CMD, Canara Bank, adds, In our banks case, the base rate is likely to go up by another 25 basis points, impacting home loans. The banks are going to raise rates even though it may mean a slowdown in the growth of the home loan portfolio.

In the last round HDFC increased lending rates by 50 basis point (100 basis point is equal to 1%) to 10.25 % for home loans below R30 lakh. Similarly, for loans above R30 lakh, HDFC hiked it to 10.50%.

The other two leading banks, SBI and ICICI Bank, having substantial exposure in housing loan market, increased lending rates by as much as 75 basis points and 50 basis points respectively. After the latest round of rate hikes, SBI's home loan customers saw their rates going up from 9.25% to 10.25%.

The quarter-to-quarter rate hikes by the banks and housing finance institutions now ensured a higher outgo towards EMI or increase in loan tenure. According to analysts, in a one-year period, the rise in home loan rates by around 2% (from about 8% to above 10% for even the best-rated customers) translates to an increase of 15% in EMI.

For existing customers whose housing loan is linked to the old system of benchmark prime lending rate (RBI has launched base rate since September 2010, where banks cannot lend at less than the base rate) has gone up as much by 200 points in a little over a year. So, a majority of housing loan customers, who had borrowed before 2008, are currently paying rates above 15%.

Financial planners say in terms of impact on the borrowers, even a minor hike can make a sizeable difference to floating-rate customers and in some cases such hikes have taken the tenure to repay home loans to even beyond 20 years.

However, bankers and financial planners say over a 20-year repayment period, the interest rate typically goes through four to five cycles of ups and downs, so the borrower should not respond in a knee-jerk manner to the spike in rates and should follow balanced strategies to cope with rising property prices and volatile rates.

MV Nair, CMD, Union Bank of India too says that the floating rate, which is applicable to most home loans, will keep on going up and comes down during a long tenure of 15-20 years and so it is the property price which plays a more important role. He says, We cant just blame interest rates, the price rise in properties, too, is responsible. With the price decision being taken by the customer himself, at the bank level, we can provide relief to the customers by making the process of documentation and turnaround time for the sanction of loan much faster. He adds, I do agree that the interest rates may go up further during the next six months, but I am hopeful that it will start moderating post-September.

BoBs Mallya says that the bank already knows the repayment capacity of its home loan borrowers from the very beginning and accordingly advises them on how to tackle the high interest rate challenges. He adds, We give some kind of relaxation in terms like foreclosure on case-to-case basis and also allow extension of repayment tenure.

Also, the rising rates cut both ways for home-loan borrowers. While older borrowers cannot increase the tenure of the loan since their retirement age is nearing, younger ones cannot afford to pay higher EMIs due to their limited income.

Since home loan customers face the prospect of even higher rates in the months to come as lending rates touch new highs, financial planners advise that the ideal solution would be to arrange funds to repay a part of the loan so that the EMI as well as the tenure remain untouched. Further, floating-rate customers should check their prevailing rate every quarter and take corrective action if it starts hurting their financial goals. Moreover, the new home buyers face a double whammy. They not only have to pay high prices for the properties but also have to pay higher interest rates.

The situation is getting difficult for real estate companies and housing finance companies, too. Describing the ground realities, RV Verma, chairman and managing director, National Housing Bank (NHB), the regulator for housing finance companies, says that the demand from the the prospective home buyer has slowed down. This will result in corrective pricing in the market. He adds, Some correction in the market is imminent, but the exact time cannot be predicted. If there is a large number of inventories of housing units, the lenders will come under pressure financially.

The situation has arisen particularly at a time when the interest rate is not likely to come down and will rather go up further. It will create a situation where potential delinquency from the borrowers cannot be ruled out, cautions Verma.

There are exceptions, though. Keki Mistry, CEO and vice-chairman of HDFC, says that the demand for individual home loans continues to be robust despite rising interest rates. Positive contributing factors include rising disposable incomes and continued fiscal incentives on housing loans, adds Mistry. Its to be seen how long will such positives outweigh negatives of high interest rates!