Choose banks over HFCs

Something seems to have changed for home loan borrowers, suddenly. After the advent of the Marginal Cost of funds-based Lending Rate (MCLR) system, existing borrowers aren’t suffering so much.

Consider the example of a home loan borrower who took a home loan of ~ 3 million from State Bank of India (SBI) on April 1, 2016, when the new MCLR system was launched. At that time, he would have paid an interest rate of 9.45 per cent a year. The demonetisation in November 2016 led to a massive drop in interest rates in January 2017 but he got the benefit only in April 2017 when his interest rate dropped to 8.25 per cent (a massive drop of 1.20 per cent) which was equal to the rate paid by new borrowers at that time.

Of course, borrowers who had joined post demonetisation were already enjoying lower rates for some time. But he will continue to enjoy the lower rates till this month and assuming the MCLR does not change in April 2018, his borrowing cost will increase to 8.40 per cent from April 2018, again the same as what the new borrowers are likely to be paying in April 2018. In other words, unlike the past base rate system or the meaningless Benchmark Prime Lending Rate (BPLR) system, existing home loan borrowers under the MCLR system have got a fair treatment vis-a-vis the new borrowers, except that the changes applied to them with a lag.

The lag is not inherently unfair because it applied both sides – there was a lag for existing borrowers even when the interest rates went up in this month for new borrowers. Nor is this restricted to SBI Home loans alone. This is true of most borrowers who have taken their home loan from banks. In fact, Citibank has gone a step further and announced a home loan linked to the three-month Treasury Bill rate, which is a completely independent reference rate announced by the Financial Benchmarks India (FBIL). It appears to be completely transparent. There does not seem to be any catch in the scheme, at least none that I could find. We will know soon as the product gets implemented on the ground. Competitive pressures may force other banks to follow suit.

So, does this mean it is the new age of fair treatment for home loan borrowers? Let’s not pronounce judgement too quickly.

The new MCLR system leaves the large section of the borrowers who have borrowed from Housing Finance (HFCs) companies in the same old rut. If a borrower, given in the example above, had taken a loan from an HFC in April 2016, he would have paid a similar rate of 9.45 per cent that time. The difference: he would still be paying around 9 per cent versus 8.20 per cent he is paying in SBI. While competitive pressures force HFCs to match interest rates for new borrowers, the same does not apply to giving fair treatment to existing borrowers of an HFC.

Clearly, banks seem to score over HFCs. However, borrowers who are not alert will continue paying the price of inertia as they have always been doing so far.

Existing borrowers of housing finance companies pay a higher interest rate compared to new ones