ATM :: Fixed rate is not fixed!

SAJJAD BAZAZ | Sat, 22 Mar 2014 |


For quite some time now, we have been witnessing volatility in interest rates that has affected borrowers of all types of loans, particularly home loan borrowers. I have come across a unique interest rate war in home loans. Fluctuation in interest rates has divided the home loan borrowers where existing borrowers feel discriminated by banks and new borrowers are passed on relief in interest rate.

Actually, one of the most common issues faced by existing borrowers is the discrepancy in interest rates paid by them vis-a-vis a new borrower. Is it really so? On the face of it, this is a valid point. So, what causes this discrepancy? Banks link the interest rates on home loans to their benchmark rate (be it the prime lending rate or the Base Rate). From this benchmark rate, a fixed rate is either deducted (in the case of a PLR) or marked up (in the case of a Base Rate) to arrive at the floating rate on the home loan. Any changes in the benchmark rate will thus automatically result in a change in the interest rate on the home loan as well.

For example, consider you have taken a home loan at 5 per cent lower than the prevailing PLR. This was the agreement entered into with the bank at the time of availing the loan. The PLR at the time of granting the loan was 15%, and the interest rate on the home loan thus stands at 10%. Now, if after some time, say 1 year, the bank reduces its PLR by one percent to 14%, then the interest on your home loan also automatically falls to 9%. On the other hand, in order to attract customers, a new borrower may be offered terms with a mark down of 6 per cent. As a result, the interest rate he gets on his home loan will be 8% only. So, it is here the discrepancy in interest rates emerges.

In this interest rate war, banks are wooing existing home loan borrowers by offering them lower rate of interest. For this, the banks offer switching facility to such borrowers. In a bid to capitalise on the falling rate of interest, the borrowers opt for shifting to a bank offering better rate. Thus he takes route of switching facility.

While availing switching facility, the borrowers have to take certain things into count. The basic attraction in the process is to get the cost of loan reduced from the exiting cost. The borrower has to bear some unanticipated costs like processing fee, stamp duty, notarization charges, insurance premium etc. This can easily work out to be 0.5% to 0.75% of the loan amount. Add to this the requirement of submitting all documentation again to the new bank. May be, these costs of switching are more than the interest relief which you expect!

In recent times, there’s increasing incidence of customers switching to other banks. Some banks have started offering switching facility to the existing borrowers within the bank itself against a conversion fee of 0.5% to 1.5% of the outstanding loan amount.

There is another serious issue with fixed rate option home loan borrowers. At the time of availing the loan, they opt for fixed rate option, which is usually a bit higher than the floating rate option. Those borrowers who opt for this option don’t want to float with the interest rate volatility. They take it that fixed rate is fixed for the entire period of the loan tenure. But when banks re-fix their interest rate midway of their repayment schedule, they get shocked. They call it cheating by banks.

Is it really cheating on part of banks to change the fixed rate? No, not at all. The borrower while signing loan agreement gives the bank this right to reset the fixed rate whenever deemed fit by the bank. Borrowers have a habit not to read loan agreement documents before availing the facility. They only come to know about terms and conditions when the banks enforce them.

The reset clause is invoked as and when applicable according to the terms of the agreement. Thus, in an increasing interest rate scenario, banks resetting the interest on the fixed rate home loan should not be a surprise.

(The views are of the author & not the institution he works for.)

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