In a rising interest rate scenario, borrowers generally tend to hold back when it comes to procuring a loan. To encourage them to take the plunge, banks often try to make the best of the situation by floating innovative loan products. But are they really as attractive as they are made out to be?
In one such move, ICICI Bank has introduced a new home loan product with a fixed interest rate for the first and second years and floating rates thereafter. HDFC followed suit this month, by offering fixed rate for the initial three and even five years.
While both banks refuse to call it a ‘teaser loan’, and named it a ‘hybrid loan’ or ‘dual interest loan’, many peer banks claim these are just teasers in another garb.
RBI’s verdict
The Reserve Bank of India (RBI) has expressed worry about such teaser loans in the past. It says that all dual loans are teaser loans and banks must make provisions for them. The RBI, however, clarifies that such products are legitimate and they have not banned such products, but only laid down rules. Banks on the other hand argue that as in the new scheme, the fixed rate offered in the initial years are on par with the current market rates and therefore, they cannot be called teasers and thus do not require higher provisioning.
The floating rates on these products are linked to the bank’s base rate and any cut in the minimum lending rate will also reduce them in future.
What is teaser rate?
Teaser loans are adjustable-rate loans, in which the borrower will have a fixed lower interest rate for the first two or three years, which changes thereafter according to the prevalent market conditions applicable at that time. SBI has initiated the scheme in 2009 and almost all leading banks joined the bandwagon. Teaser loans became very popular in a short span because the borrower knew that EMI would not change, even if for a short duration.
Banks positioned the loans as ideal for higher loan amounts. The banks also rationalised that when EMIs increased after the first two or three years, the income of the borrower would have gone up, offsetting the increased repayment liability. In October 2010, RBI intervened and increased the standard provisioning requirement for dual loan products from 0.5 per cent to two per cent in order to discourage banks from going overboard lending at fixed rates. This was mainly to ensure that the banks had made provisions for potential bad loans. Following this mandate, banks withdrew the schemes.
Is this good for you?
Let’s take an example. When a customer opts for a hybrid loan at the rate of 10.75 per cent from HDFC, the EMI will be fixed for `10,150 for three years against the loan of `10 lakh. If in 2013, the rates come down to 8.5 per cent, the EMI for `10 lakh will be `8,680, but the borrower will continue to pay the same EMI for one more year. That means in the year 2013 alone, the borrower’s loss will be `19,360.
In 2009, when the economy was moving up, the interest rates too were climbing. But in the current scenario, it is expected that interest rates may go up by 50-100 basis points (0.5 to 1 per cent) in the near future and then will start to fall within two years. So if a borrower opts for the new scheme, most likely, he might lose out on the possibility of a downward trend in interest rates, as he will have to pay higher EMIs, when interest rates are down. Also, it has to be noted that the rates for the new dual rate loans are actually higher for larger loan amounts and for others it is on par with the ongoing rates. Make sure that the financier provides a clear amortisation of the loan repayment.
In this rising home loan interest rate scenario, a buyer needs to be very cautious in his decision making. If you are comfortable with the prediction that interest rates will fall, the new dual-rate loans are not for you. If, however, you are the type who wants the comfort of knowing that your EMI is fixed for even a short duration, you could consider it.
(The writer is the CEO of bankbazaar.com)