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Since 1st March, 1999
 
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Licence to switch

Home loan EMIs are likely to go up again. However, this time you may be able to switch your lender if it is charging a higher interest rate without paying any loan prepayment penalty.

Rate hike signal

In September, when the Reserve Bank of India increased its key policy rate by 0.25 percentage points, most of the commercial banks didn’t pass on the hike to the borrowers in the face of ample availability of cash in the system, low credit demand and growing incidence of loan defaults.

On October 25, the Reserve Bank hiked its policy rate by 0.25 percentage points for the 13th time in the last 18 months. At the same time, the banking regulator also deregulated interest rate on savings bank deposits which, bankers fear, will raise their overall cost of funds.

Private lenders Yes Bank and Kotak Mahindra Bank have already increased the interest rates on savings deposits. Others are likely to follow suit.

State Bank chairman Pratip Chaudhuri said the deregulation of interest rates would increase the bank’s weighted average cost on savings deposits by 1-1.25 percentage points. Given that the bank’s savings deposits comprise more than 25 per cent of the total deposits, an increase in interest cost by 1 percentage point means its overall cost of deposits will go up by a minimum 0.25 percentage points.

Bankers also say that interest rate on savings deposits after deregulation will stabilise in three to four weeks, that is by November-end.

Thus, by November, banks will have to absorb a 0.75 percentage point increase in their cost of funds (deposits plus borrowings from the Reserve Bank) if they choose not to pass on the higher cost to borrowers.

On October 28, banks borrowed Rs 59,345 crore from the Reserve Bank at an interest rate of 8.50 per cent, which is the current repo rate after the 0.25 percentage point hike on October 25. The amount borrowed on a single day shows the liquidity shortage in the banking system, which is less than one per cent of the net deposits of banks.

This shortfall is likely to increase in December because of withdrawal demand for advance tax payment along with higher demand for credit in the busy season. Also, the government’s plan for borrowing an additional Rs 52,800 crore in the second half of the current financial year will add to the shortfall.

Thus, banks will be forced to increase their lending rates in December, if not in November.

Search for alternative

Any increase in lending rates by banks will certainly burn your pocket in terms of EMI payments that have already gone up significantly in the past 18 months.

The increase in the EMI outgo will be lower for those who are in the closing years of a home loan repayment schedule. In home loan EMI amortisation, interest payments are front-loaded.

This means that during the initial years, a larger part of your EMI outgo is towards interest payment and only a small portion of the principal borrowing is repaid. So, if you are in the initial years of a home loan repayment, the hike in interest rates will affect you more.

It, thus, makes sense for home loan borrowers who have taken loan in the last 3-4 years to look for a cheaper option.

So far, banks have been charging a penalty of 2-3 per cent on the principal outstanding if a home loan borrower wants to switch to another lender offering a lower interest rate. This clause restricted many borrowers from changing lenders because the difference in interest rates offered by various lenders hardly exceeded 1.5 percentage points.

This prepayment penalty clause may be scrapped from December if the RBI governor’s statement during the mid-term monetary policy review is any indication.

In fact, the National Housing Bank (NHB), the regulator for non-banking housing finance companies, has already issued notices to stop imposing prepayment penalty charges.

The NHB has also directed the housing finance companies not to differentiate between an existing and a new borrower.

The problem of differences in interest rate offers has already been settled after the implementation of the base rate system. However, there are many instances where a bank discriminates between an existing and a new borrower with differential interest rates. A borrower can always complain to the banking ombudsman as a bank cannot charge differential interest rates unless the creditworthiness of the borrower has undergone significant changes.

Prepayment benefit

Most banks now do not charge the prepayment penalty after a few initial months if the loan is prepaid from the borrower’s own income sources. However, if the borrower wants to shift the outstanding loan to another lender, the penalty is imposed.

The banking ombudsmen’s conference in September and the Damodaran Committee on banking services had suggested that the prepayment penalty should be abolished if the loan was taken on a floating rate basis. However, the penalty could continue in cases where the loan is taken on a fixed rate basis.

Though banks have agreed to this recommendation, they had not yet implemented the same till date.

“We will pursue banks to do this (ending prepayment penalties) as soon as possible. But should the system require some time to adjust to this, we are prepared to give them,” RBI governor D. Subbarao told reporters at the customary post-policy press conference after the monetary policy announcement.

If the ban on home loan prepayment penalty comes into effect, more than 80 per cent of the borrowers in the country will benefit as they can choose and change among lenders offering lower interest rates without paying a penalty for prepaying the loan with the existing lender.

In the face of competition, this is likely to bring in a kind of parity in the home loan rates of various lenders. At the same time, banks are likely to increase their loan processing and documentation fees.

This is because every time a home loan borrower switches lenders, the documentation and the processing of the loan have to be done afresh. So, you need to be careful about the associated cost of the home loan when you plan to change your existing lender. A lower interest rate could only be one point of reference for changing a lender.

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