The Telegraph
Monday , January 4 , 2010
Since 1st March, 1999
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Look before you leap

Home loan borrowers now have a rich spread of enticing offers to choose from. And, they are losing no time in grabbing the low-cost financing options as is evident from the increased number of loan applications.

The State Bank of India is getting 350 home loan applications on an average everyday in Calcutta after the bank launched its “My Home” campaign, offering an 8 per cent interest rate. This is more than double the number of applications the bank used to get before.

The encouraging response from borrowers prompted the SBI to extend its offer to March 2010 from November this year.

Other lenders have intensified the rate war by reducing their rates to catch up with the SBI.

Some such as the Bank of Rajasthan and Development Credit Bank have gone a step further and reduced their rates below 8 per cent to wean away a section of the ever increasing queue of borrowers.

A lower rate may be attractive when you are borrowing a large sum for a home loan.

But it may not be wise to sign on the dotted lines without a proper understanding of the clauses on offer.

Be informed

Ignorance is bliss. But when you are buying a financial product, it is a bane. If you don’t understand the underlying risk of a financial product, you may find yourself in trouble later.

In a long-term product like a home loan, the greatest risk is the interest rate. Now, you no longer get a home loan on a fixed interest rate covering the entire term of the loan as most banks offer fixed rates with a clause of rate reset every three or five years.

So, you will have to be more careful about how the lender proposes to adjust the interest rate after the expiry of the “discount” period in such “teaser rate” offers.

The lender offers a teaser interest rate for a couple of years initially at a discount to its normal card rate. After the expiry of the initial discount period, the interest rate is restored to the card rate prevailing at that time. Now, why are the banks offering much lower rates to new borrowers, while charging higher rates from existing borrowers? Existing borrowers are also not allowed to switch to lower rates.

Teaser tussle

Teaser rates are offered during a declining interest rate regime.

In a falling interest rate regime, deposit rates come down faster and to a greater extent than lending rates.

Thus, it becomes easier for lenders to lend (on the basis of the lower cost of deposits) at a discount to its existing card rate and, hence, increase its loan portfolio (considered as assets for a lender).

When interest rates start going up, a borrower of teaser rate finds his/her EMIs suddenly going up appreciably post adjustment (of the borrowing rate) to the lender’s benchmark lending rate.

Let us illustrate this with examples. We will take two instances — the State Bank of India and HDFC.

The SBI is offering an 8 per cent interest rate in the first year, 8.5 per cent in the second and the third year and from the fourth year, the interest rate will be 2.75 percentage points below the prevailing SBAR (benchmark lending rate) at that time.

The bank’s benchmark lending rate is currently at 11.75 per cent.

HDFC’s benchmark lending rate is 13.75 per cent at present.

In July, the country’s largest home loan lender reduced the rate to 8.75 per cent for fresh loans up to Rs 15 lakh, while existing borrowers continued to pay 9.25 per cent.

Now the housing finance company has come out with a teaser offer in which a fixed interest rate of 8.25 per cent will be charged till 2012 and thereafter the rate will be adjusted to 4.5 percentage points below the benchmark lending rate.

For a loan of Rs 10 lakh for 10 years, the EMI for the first year will be Rs 12,132 if you had taken the loan from SBI. It will be Rs 12,265 if you take the loan from HDFC.

For the SBI loan, the principal outstanding at the end of the first three years will be Rs 7,93,231.

In the case of HDFC, the principal outstanding at the end of first two years will be Rs 8,66,181.

EMI riddle

Let us now consider three cases — the benchmark lending rate of the two lenders remains the same, it increases by one percentage point, and decreases by one percentage point — and see what happens to your EMI.

In the first situation (where the benchmark lending rate doesn’t change), the EMI for the SBI loan will be Rs 12,762 and that of the HDFC loan will be Rs 12,802.

In the second situation (where the benchmark lending rate increases by one percentage point), the EMI for the SBI loan will be Rs 13,168 and that of the HDFC loan will be Rs 13,258.

In the third situation (where the benchmark lending rate goes down by one percentage point), the EMI for the SBI loan will be Rs 12,363 and that of the HDFC loan will be Rs 12,355.

It, thus, can be seen that whatever be the situation, increase or decrease in interest rates, you shall have to pay a higher EMI once the discount rate period expires.

Teaser rates may tease you into taking a home loan offered under special schemes, but you need to take a long-term view to have a proper idea of the EMI you will ultimately have to part with.

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