Tips for Home Loans

Housing loans are a popular means to owning a home. There are certain issues related to the pricing of home loans that needed to be addressed by the banking regulator RBI.

1) Differential Pricing –
Anybody, who has an existing mortgage on his/her home, would be aware that their banker is charging a much lower rate of interest to new borrowers. Banks are still charging up to 12 % on older loans while new rates range from 8 % to 9 .The difference in interest costs, between the old and new, thus being over 30 % in many cases.

2) Downward stickiness –
While banks have been very quick in raising rates on home loans when liquidity conditions were tightening, they have not shown similar abilities while reducing them despite liquidity conditions being conducive to lower rates. This is mostly because of PLR based pricing. The PLR (Prime Lending Rate) means the rate given by a bank to it most credit worthy borrower. In the PLR system banks can price their loans much below this rate depending on their cost of funds. The PLR does not reflect the real cost of funds for a bank and they may keep the PLR rate stagnant despite a fall in cost of funds Since your floating rate loan is pegged to PLR , you will see no fall in your interest payments even when overall interest rates are falling.

3) Reference Rate ambiguity –
Most borrowers find the pricing of home loan rates very ambiguous. They simply find that their loan rates have increased or decreased after a receipt of letter from their lender.

A few months back, The Banking Codes and Standards Board of India (BCSBI) has asked its member banks to publish the reference rate to which its floating rate loans are tied. The banks have also been asked to publish any changes made to the reference rate. Hence you will no longer need to wait for the banks letter to arrive before you know of the expected increase in the loan rate.

The latest in RBIs initiatives to bring transparency is the draft guidelines on introduction of base rate which is computed on a cost plus basis. This base rate will be the floor price for all lending .This system will replace the existing prime lending rate system. In the base rate system, the base rate will be the minimum rate below which banks will not be allowed to lend. All loans will be pegged to the base rate. Thus when a banks’ cost of funds fall your floating rate will automatically come down.
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Unfortunately the new guidelines will probably resolve only two of the issues discussed above. It will reduce the downward stickiness of rates, and allow borrowers to know the reference rate to which their loans are linked but will not resolve the issue of differential pricing that is unfair to existing borrowers .This issue will probably require RBI to draft another set of guidelines which make it mandatory for banks to have similar rates of interest for both old and new clients.