Cheaper exit

Written by Saikat Neogi | Updated: Aug 14 2012, 05:48am hrs
Dual or special rate loans taken from HFCs will now attract preclosure norms applicable to fixed & floating rate loans. What it means for you

There is reason for cheer if you have taken a home loan from a housing finance company on teaser or special rates as, now, you will not have to pay any penalty on preclosure. The National Housing Bank (NHB), in a circular, has scrapped the prepayment penalty. It has said that all dual or special rate loans which are a combination of fixed and floating housing loans will attract the preclosure norms applicable to fixed and floating rate.

The NHBs new order will cover all housing finance companies, such as HDFC and LIC Housing Finance, and will benefit borrowers who had taken teaser rate loans introduced by banks and housing finance companies in 2009 after the global financial crisis to boost credit offtake and real estate sales. The teaser rate offered in 2009 was around 10.25-10.75% and the floating rate interest at that time was around 11.5-11.75%.

The NHB circular issued to all registered housing finance companies (HFCs) has stated that there is a wide variation or non-uniformity in the features of the products offered to the customers by HFCs.

The lack of uniformity has been observed across the industry also by the same lending institutions at different times, including the relative periods of fixed vs floating rates in the dual rate/special rate loans, and mostly marginal concession in interest rates, if any, during the fixed interest duration by HFCs compared to the total tenure of the loan, said the circular.

It added, It is also observed that this wide variation in the product features reflects the lack of uniformity and transparency, not considered healthy for the system.

Earlier, the Reserve Bank of India (RBI) had scrapped prepayment charges on dual rate schemes offered by banks. In fact, the country's biggest lender, State Bank of India (SBI), was the first to offer home loans at lower interest rates for the first five years of the credit period, popularly called as teaser rates.

After the end of the special period, the loan would either move to a fixed or a floating rate, depending on the current card rate. Some lenders like Axis Bank had already stopped charging a prepayment penalty even before the central bank;s notification.

However, for fixed-rate loans, banks will continue to charge the prepayment penalty.

Analysts said the NHB notification would benefit customers who have taken loan from housing finance companies. They also said that prepayment made sense if one was doing it in the first 4-5 years of the loan when the interest outgo is maximum. Since teaser rates were introduced four years ago, it will make sense to prepay as there will not be any penalty, said Anmol Singh, a financial consultant. He said a borrower must avoid prepayment if he is exhausting all funds. One must keep some cash, ideally in short-term fixed deposit or liquid funds of mutual funds, to meet any emergency expenses, he says.

Last year, a committee headed by former Sebi chief M Damodaran had suggested banning the penalty charged by banks on prepayment of loans, something that various consumer groups have in the past urged the central bank to do.

The committee had observed that foreclosure charges levied by banks on prepayment of home loans were resented by borrowers across the board, especially since banks were found to be hesitant in passing on the benefits of lower rates to existing borrowers when interest rate moved down.

Bankers, however, said that by charging for prepayment, they manage their asset-liability gaps better and stop borrowers from shifting to other banks. Typically, most banks penalise prepayment and even do not allow prepaying in the first 3-5 years of the loan as it distorts their asset-liability mismatch.

However, prepayment beyond this period is free, provided you pay it from your own resources and do not take any loan to prepay the home loan.

Also, before you prepay the full amount, do calculate the tax benefits you would lose out on. Prepayment would reduce the tax benefits on interest and principal payments.

Section 24 (b) of the Income Tax Act, 1961, allows a deduction of interest payment up to R1.5 lakh from taxable income for self-occupied properties. Under Section 80C, principal payment up to R1 lakh, inclusive of other investments, can be deducted from the income while calculating the tax liability. So, in such a case, prepayment makes little sense.

Analysts said with the removal of preclosure penalty on all kind of housing loans, a borrower from a housing finance company could negotiate with the company to reduce the spread. A lower spread helps a borrower in the long run. The borrower will have to pay a certain amount it is typically 1-1.5% of the outstanding loan to bring down the spread.

A lower spread will reduce the equated monthly installment or bring down the number of years to pay the loan. It is still better than paying the processing fee to take a fresh loan to pre-pay the existing loan, said Prashant Sharma, a financial analysts.

Financial planners said partial prepayment of a loan made sense at a time when interest rates were going up as it would bring down the tenure or even reduce the EMI.

Does it make sense to prepay

* Prepayment makes sense if one is doing it in the first 4-5 years of the loan when the interest outgo is maximum

* Before you prepay the full amount, do calculate the tax benefits you would lose out on. Prepayment would reduce the tax benefits on interest and principal payments

* Section 24 (b) of the Income Tax Act, 1961, allows a deduction of interest payment up to R1.5 lakh from taxable income for self-occupied properties. Under Section 80C, principal payment up to R1 lakh, inclusive of other investments, can be deducted from the income while calculating the tax liability

* With the removal of preclosure penalty on all kind of housing loans, a borrower from a housing finance company could negotiate with the company to reduce the spread. A lower spread helps a borrower in the long run