An old colleague called me up after reading one of my articles. We spent some time reminiscing about the old times and the people we had worked with before he came to the real reason he had called me. I knew he had lost his job in 2009 and his divorce had also put a lot of pressure on his finances. Although as a finance professional he understood the value of a good credit standing but circumstances had forced him to start defaulting on his car loan and credit cards after his entire savings were wiped out to pre-pay the home loan (his ex-wife got the flat) and to meet his day to day expenses during his unemployed days. He wanted to make a fresh start as he had just managed to get a job offer but his defaults were now beginning to affect his life. He was aware that he would need to repair his credit standing but was not aware of how to go about it. That rang a bell. I have been asked similar questions by a lot of people who either through circumstances (like my friend) or because of lack of financial discipline had defaulted on their financial obligations but were now wanting to make amends but did not know how to.

First a crash course on what happens when you default on your financial obligations. Today every lender is required to share data about the repayment history of their borrowers with at least one credit Information Company (generically known as CIBIL – since Credit Information Company of India Ltd Or CIBIL is the largest and the oldest of the 4 licensed credit information companies). It is a popular misperception that lenders share repayment data only about customers who default on loans. They are required to share data about the repayment of all their borrowers. So anybody who has taken in a loan (and that includes me as well) and is currently servicing it will find “his or her name in CIBIL”. But for most of us this is extremely useful. If I were in the market for a new loan now the banks will be happy to lend to me at good rates simply because they will discover that my existing loan repayments have been bang on time and the level of indebtedness is very reasonable. The issue of course arises if my credit information report shows defaults (current or past).

This credit report has special significance in today’s life (obviously after our school’s report card) as it determines the credit worthiness of any individual. The need for credit is important aspect of modern day life, which one can hardly do without. The day is not far when matrimonial alliances will be based on the credit reports of bride and the groom…so till death do us apart will probably be replaced by …till finances do us apart.

So if you have defaulted on your payments for any reason, your Credit information report will immediately disclose this status to any prospective lender. With a bad credit report it is highly unlikely that you can get any loan or credit card from any bank.

But all is not lost…you can slowly and gradually build your credit history all over again.

Now that you have been reported a defaulter, and you are burdened with debt, then what should you do? The help comes in the form of specialized credit counseling agencies who can assist you in such a situation. The well-known ones are ICICI initiated venture Disha Trust (www.dishafc.org) or Bank of India initiated Abhay Credit Counselling (www. abhaycreditcounselling.com) which assists you in negotiating with your existing lenders and re-structuring your debt, which can be curative and preventive both.

“The customized advise given by Disha Trust is absolutely free irrespective of the bank the customer has a defaulted with and not just ICICI bank,” shared Ms. Nutan Lugani - Counselor of Dish Trust. She adds, “ We hold extensive counseling sessions with the customers then work out an action plan and accordingly make recommendation to the banks. It is not mandatory for the bank to consider them but it is a win win situation for both, the bank and the customers. With restructuring or rescheduling of loans, banks recover their money without incurring costs of litigation etc. and customer gradually comes out of debt.”

So all is not lost. If you are considering obtaining a loan in future with low interest rates, you must have a healthy credit score. “Worrying too much about your bad credit history is not going to help, but doing the right things will certainly help, “ adds Ms. Lugani.

First start with paying off the re-structured debts and start the process of rebuilding your credit history. But remember, rebuilding your credit history is a slow process. It is a misperception that if you could somehow find the money and pay off all the debt now it will give you a clean slate. What the report will show is that you had defaulted in the past but that you cleared everything off at a particular point of time. That coupled with some other steps should help you in slowly rebuilding your credit history. Ms. Lugani says, “ Customers should not be obsessed about CIBIL credit report. They should first think about the loan, which they have to repay, and the need of the hour is how to come out of it, CIBIL report is secondary. Once you regularly start paying your debts in time then with the passage of time your credit history will improve.”

Remember CIBIL keeps your records for 7 years but displays the month-by-month repayment record only for the last 36 months. What it means is that if you start maintaining a clean history after re-structuring or paying off your loans than your credit history will start looking good after 3 years. Of course CIBIL also computes a Credit score (the process is internal to CIBIL) for each individual, which probably is based on the entire 7 years data. However, currently only a few banks use the Credit score so it is your visible data for 3 years that has more relevance.

In the meantime you can also start adopting measures, which enable you to rebuild credit history like taking secured credit cards, which are given against the security of your Fixed Deposits. Your credit limit will probably be raised in future if you have shown good financial behavior. These credit cards may not be your dream cards, but they are often the best option you have since you are unlikely to be eligible for their regular credit cards.

You can also opt for secured personal loans where an asset is required as collateral. It normally involves bigger sums of money, moreover secured personal loans are preferred by the lenders due to the fact that they are secured against your assets such as jewelry, securities such as shares/mutual fund units, bonds, NSC, KVP, Life Insurance policies with high surrender value, etc. All these loans (with the sole exception of Loan against property which is unlikely to be available for somebody who has defaulted in the past) are available irrespective of your credit record.

Ms. Lugani concurs, “Such customers should look at liquidating the existing liabilities by taking loan against some kind of security, whether it is of stocks and shares or gold, or consider borrowing from some rich relative who can give them at a much lower rate. But word of caution here is that check your expenses, do not increase your credit exposure and repay the present loan to salvage the situation immediately.”

You should pay more than the minimum payments each month if you cannot afford to pay off the credit card fully. Loan, whether big or small needs to be serviced and repaid regularly and on time. Service these loans religiously and the new disciplined you will also reflect in your repayment history in CIBIL records. In fact after three years the remanents of your bad history will no longer be visible.

So remember – slow and steady wins the race.

Next week I intend to cover how to get mistakes in your credit report corrected. I invite readers to share their experiences on this issue.

And No, this question is not asked in the political context with our Northeastern borders racked by chronic insurgency and of course the unrest in J & K.

It is not even in the context of a common single market where many foreign direct investors will testify that this is not just a rhetorical question. In fact the early investors in the India story discovered the maze of local taxes, levies and regulations divided India into many small markets (of which some were more profitably serviceable from manufacturing locations located outside India rather than from a location within India). Anyway much water has flown down the Ganges since those early days and the impending implementation of the Goods and Services Tax would perhaps be the culmination of a series of steps that have already been initiated in recent years to forge a common India market.

The question is in the relatively mundane context of Home loans. Recently I spoke to a friend of mine who wanted to a buy a flat in Kolkata while he was working in Mumbai. He wanted to use my expertise on home loan to suggest solutions for a problem that he was facing in getting a loan. He approached a bank in Kolkata who said they would have given him the loan as both the property and his income papers were in order, but they asked him to visit their branch in Mumbai to get a loan as he was working in Mumbai. When we came back to Mumbai after finalizing the property in Kolkata, he approached the branch of the same bank only to be informed to visit a branch in Kolkata as the property is in Kolkata and they need to value the property before giving the loan. This friend of mine had already paid Rs. 51,000 for booking amount and if he was unable to book the flat, the developer would return back only 50% of the booking amount (after negotiations as the developer was not ready to return a penny out of it). Tensed with all these issues, he called up asking me – Is India really one Nation? The property was ready to move in with all title documents and his loan eligibility was coming around to more than Rs. 20 lakhs (he needed only Rs. 14 lakhs).

I decided to do some research on the same as the number of people moving to other cities for work has been increasing significantly and this may be a common problem faced by quite a few of them who either have plans of relocating or to buy a property for their parents in their “home” city. We have also seen an increase in the number of similar queries we receive on Apnapaisa.com.

We did a round of mystery shopping as well as spoke to the major home loan players. Here is what we found. When we spoke to the players officially each of the players said that such loans are no problems as they have a single common system across the country. However the situation on the ground was a little different. From among the lenders we spoke to as mystery shoppers only HDFC and ICICI followed up on our initial call (we had dangled the bait of Rs. 70 lac home loan). Even the official we spoke to in a SBI branch assured us that they would be able to do the transaction subject to their normal credit and operational checks. The other two private sector banks and the one foreign bank that we spoke to (or visited) as mystery customers either told us that they could not do such a deal or did not respond back after taking down the initial details.

We already knew a few DSA’s (who are our clients as advertisers on our site) and we thought of getting this answered from them also. We spoke to a large DSA based out of Mumbai who serviced many banks. His feedback corroborated our own findings on mystery shopping.

Another DSA we spoke to in Mumbai (who did not work with either HDFC or ICICI) said he would be able to get the transaction done provided the project in Kolkatta was pre-approved by any of the banks he worked for.

I also did a bit of informal talking with the private sector banks that had turned down (or did not show much interest in) our mystery shopper. What came out was that none of them had an effective loan origination system across the country and unless the loan amount was big enough the amount of effort required to co-ordinate with another city was just not justified. Each office is driven by its own KRAs and as legal checking work done for another office was not counted as part of their KRAs this clearly did not enjoy any priority.

What it boiled down to was that a loan that was clearly falling within their credit and legal norms of the bank was being given up simply because of the mismatch of KRAs between the two branch offices. Of course for a determined customer this would still be possible but it might take a lot more time than usual.

The only saving grace to come out of this story was that at least for a few lenders India was a “single” country.

Amen.

Disclosure: Most of the banks mentioned in the article are advertisers on Apnapaisa.

“Loan rates set to be more transparent” screamed newspaper headlines on Thursday after a draft RBI circular asked banks to shift to a “base rate” mechanism from the existing “BPLR” w.e.f April 1, 2010.

The existing “BPLR” structure for pricing floating rate loans has exhibited what bankers politely call “downward stickiness”, which means that the BPLR refuses to go down (or goes down reluctantly and at a slower pace) when bank’s cost of funds fall, though it is quick to go up when their cost of funds go up. In effect existing loan consumers continue to pay higher interest rates even in a falling interest rate market but are forced to pay more when interest rates go up. As taking a loan (primarily home loan) becomes more prevalent it affects millions of middle class households and the furore over this non- transparent method of fixing floating rate loan products has reached feverish pitch.

The banks on their part give a curious argument to justify charging more to their existing home loan consumers whilst doling out lower rates to attract new customers. They claim that as interest rates fall only for the new incremental deposits and since the existing consumers are funded from existing deposits (which are at a higher rate), they cannot be given the benefit of the fall in rates immediately. The reason this argument does not appear wash is because by this token when interest rates rise, only the new customers should be paying the higher rate (since only they are funded from the new high cost deposits) whilst the existing loan consumers should continue to pay less. Of course this never happens.

When interest rates go up, they go up for both the new and old customers. Bankers again have a justification for even this. According to them when interest rates go up their existing depositors break their lower cost deposits to make fresh deposits at higher rates. There is no data presented by them to support this contention (of customer churn old deposits for new deposits at higher costs) and it is difficult to believe that a large body of Indian depositors overcome their legendary inertia just to take advantage of a 0.25% or 0.50% increase in deposit rates.

In any case this completely overlooks the fact that managing the “treasury” is a core function of the bank and it cannot pass on this responsibility (or cost) to its loan customers. Another argument given by bankers is that if the true cost of this “treasury” management was to be included in the loan pricing then all loans will be more expensive to start with (though they will be transparent). I am willing to stick my neck out and say that given the choice between a cheaper but non-transparent loan to a slightly more expensive but transparent loan, most consumers will opt for the latter. In fact this presents a unique opportunity for a consumer bank but more of that later.

Now coming to the draft RBI circular which differs from the recommendations of the Mohanty committee in two very crucial aspects. Firstly the committee had recommended that the “Base Rate” be calculated in a very specific manner with the starting point being the bank’s 1 year deposit rate. What the RBI circular says is “While each bank may decide its own Base Rate, some of the criteria that could go into the determination of the Base Rate are: (i) cost of deposits; (ii) adjustment for the negative carry in respect of CRR and SLR; (iii) unallocatable overhead cost for banks”. In effect each bank will be able to fix its own base rate without necessarily having to justify its calculations. This does not give much confidence that anything much will change from the BPLR dispensation. There have been numerous exhortations from the regulator that BPLR was to be fixed with reference to the cost of funds of a bank.

Secondly the committee had recommended that the Base Rate be revised at least once every quarter which is again not insisted on in the RBI’s draft circular.

So unless something changes dramatically, the expectation that loan interest rates will be fixed in a more transparent manner, is likely to take a long time to realise. There is one (unintended?) impact of the draft circular. The artificial cap on interest rate on education loan may no longer apply and hence this crucial (but risky product from the bank’s perspective) may at last take off.

To conclude here, I think that the path to more transparent loan pricing will have to be traversed through legislation rather than from regulation.

Let’s see if our political class will come to the rescue of the loan consumer whereas regulator has been unable to do so.

The RBI has recently expressed its concern about the teaser loans, stating,

“In the area of housing loans, teaser rates are increasingly being offered which is a cause for concern. I hope banks are ensuring that borrowers are well aware of the implications of such rates and the appraisal takes into account repaying capacity of the borrowers when the rates become normal.”

The point being made was that when the “teaser rate” period is over (2-3 years in most cases) and interest rates shift to the normal floating rates prevalent at that time the consumers may not be able to cope up with the resultant increases in EMIs (especially if, as widely expected, interest rates go up significantly in the meanwhile).

I give a small calculation here for the better understanding of ‘teaser rigmarole.’ Take the case of a typical 30-year-old salaried person with a net salary of around Rs. 40,000. As per the eligibility calculations he would be able to get a loan of Rs. 20,00,000 from State Bank of India (SBI). (See box for eligibility calculation)

How do “teaser rates” work?

SBI who pioneered these loans prefers to call them “Low cost” loans rather than “teaser rate” loans. Whatever be the label, in the Indian context, it has meant loans in which the interest rates are fixed for the first 2-3 years (5 years also in a couple of cases) and which reverts to regular floating rates after the initial fixed interest rate period is over. For example for a loan of Rs. 20 lakhs SBI would charge a fixed interest rate of 8% in the 1^st year and 8.50% in the next 2 years and from the 4^th year onwards it will have a floating rate of 2.75% below SBI Advance Rate (currently 11.75%) effectively meaning that if SBI Advance rate remains where it is today the rate in the 4^th year will be 9% (SBAR of 11.75% minus 2.75% = 9%). The EMI per lakh on this basis works out to Rs. 836 in the first year Rs. 867 in the next 2 years and Rs. 895 after 3 years.

If he went for the normal option of regular floating rate loans he will get an interest rate of 8.75% (EMI per lakh of Rs. 884) and will also be eligible for a similar loan amount of Rs. 20 lakhs.

If we run a simulation to see what happens if the interest rates rise by 2% in 2010, 1% in 2011 and another 1% in 2012 – or a total of 4% in the next 3 years. As a result in the case of the SBI home loan the interest rates from the fourth year goes up to 13%. If he had gone for the floating rate loan the interest rate would be 10.75% (original rate of 8.75% plus 2%) in the first year, 11.75% in the second year and 12.75% for the period after that. The Instalment to Income ratio in both cases go up sharply from 44% to 57% (indicating that a larger proportion of the income will go towards servicing the home loan) at the end of 3 years and in both cases are almost at the same levels. This means that irrespective of the type of loan the degree of difficulty in repayment would be similiar in both the loans if rates increase steeply by 4% over 3 years.  In both cases an 8% annual increase in income will ensure that the Instalment to Income ratio remains at the original levels. Of course in the regular floating rate loan the consumer ends up paying for the increase in interest rates in the first 3 years also.This increase will ensure that the Installment to Income ratio falls back to the mid forty levels that are considered safe by Indian standards.

How is loan eligibility calculated in a “teaser rate” loan?

The loan eligibility is calculated taking into account the EMI after the teaser period is over. As per the above example the EMI per Lakh of loan in the 4^th year would be Rs. 895. Typically the banks assume that 40% to 50% of the net income is available for repayment of home loan. Therefore from the income of Rs. 40,000 about Rs. 16,000 (40% of Rs. 40,000) to Rs. 20,000 (50% of Rs. 40,000) is available to be paid as an EMI. Based on an EMI repayment capacity of Rs. 16,000 to Rs. 20,000 and an EMI per lakh of Rs. 895 we can back calculate the loan eligibility amount at Rs. 18 lakhs to Rs. 22 lakhs or say around Rs. 20 lakhs.

So clearly whether the consumer chooses the “teaser rate” product or the regular floating rate product he would face some difficulty if interest rates rise steeply as the IIR will increase to uncomfortable levels of 55%+. The IIR can fall back to reasonably comofrtable levels if net income rises by 8% p.a. which should not be a big issue if our overall economic growth  does not falter.

What would perhaps help, both banks and consumers, is if a transparent regime is put in place to ensure that increases in interest rates (and decreases for that matter) are worked out on a transparent and objective basis so that consumers are better prepared for such increases and the actual increase doesn’t come as a shock to them.

The Reserve Bank of India has hiked the Cash Reserve Ratio by 0.75% to 5.75% (as against the existing 5%) in the third quarter review of monetary policy announced today which will be implemented in two stages. The Central Bank has left unchanged the Reverse Repo, Repo, and Bank rate at 3.25%, 4.75%, and 6% respectively.

So what does all this translate into for customers like you and me?

For what is CRR and how it affects interest rates, please see box.

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What is Cash Reserve Ratio (CRR)? Banks are mandated to keep certain percentage (now increased to 5.75%) of their deposits with RBI. This is the Cash reserve and the %age required to be kept as a cash reserve is called Cash reserve ratio or CRR. Thus, an increase in the CRR leads to banks being forced to keep more money with RBI reducing the funds available for lending. As less money is available to the bank to lend there is bias towards increase in rates as per the normal laws of supply and demand. So an increase in CRR will normally result in an increase in interest rates (and vice versa a reduction in CRR will normally result in a reduction in interest rates).

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The quantum of the increase is at 0.75 % was a tad higher than the market consensus of around 0.50%. RBI has increased the target growth for 2009-10 from 6% to 7.5% for the year, and have clearly indicated that their policies will now shift from ‘managing the crisis’ to ‘managing the recovery’, and thus reverse some of the earlier steps undertaken to provide liquidity in the market. They have also indicated that the “recovery is getting established and inflation fears are coming true”. In fact we can expect more such action including increase in Repo rates, Bank rates Reverse repo rates. (See box for what these rates are and their impact.)

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What is Repo Rate?

The repo rate is the rate at which RBI lends short-term money to banks under a specific secured mechanism. When the liquidity in the markets is high, the RBI increases the rate at which it lends to the banks to make it more expensive for the banks to borrow money from RBI. Thus banks have more expensive money with them to lend to consumers and have in turn to increase their own rates. Thus increase in repo rates have a bearing on other interest rates like your bank FD rates, home loan rates, and so on.

What is Reverse Repo Rate?

It is a mechanism by which banks can park short-term money with RBI. The rate of interest that the bank gets from RBI for such money thus becomes the floor rate for all interest rates at this return is guaranteed to the banks. When this rate goes up naturally the overall interest rate will tend to increase as well.

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How are consumers impacted with these economic moves?

If you strip away the conservative language favoured by all regulators, it clearly means that interest rates are on their way up as far as the regulator is concerned, and hence we will definitely see an increase in overall interest rate during this year. But the quantum of the increase will depend on how inflation shapes up, and that in turn will depend on a host of factors such as demand for credit, monsoon, etc.

Still the question remains how does it affect you and me?

For savers and investors: If you are thinking of depositing monies with banks, then it is advisable not to get into long term deposits. Instead of making a 5 - year deposit you should make a 6/12 month deposit, as it is very likely that when the renewal comes up then you will be in a position to get far better rates.

For new loan consumers:

If we look from a borrower’s perspective, interest rates may not get affected immediately (in the next 45 days or so) but clearly there will be an increase in interest rates the near future. So if you were going to buy a home or a car in the near future, then it makes sense for you to prepone your borrowings immediately and go in for the current teaser rates into the safety of fixed rates for at least 2-3 years. Teaser rates for a year or so are available in car loans as well and customers should look at that also.

For existing loan consumers:

Well if you were smart enough to have taken a teaser loan in the last 6-9 months then just wait and watch since you have already made the right move. But if you have borrowed on a regular floating rate, then you should immediately shift to a teaser rate loan. Do it in next two – three weeks itself before interest rates start to harden or the teaser rate schemes are withdrawn. I repeat – do it now!!! If necessary the shift can be to the same bank from their regular floating rate loan to a teaser rate loan.

Sure the teaser rate loan only secures you for the medium term (the first 2 -3 years)

But it is better than nothing. To quote John Keynes “ ….in the long run all of us are dead….!!!

Amidst all the hype & hoopla surrounding the home loans (teaser loans), there are customers who are still facing the dilemma to remain fixed or to float. They do not want the risk of floating especially when interest rates move upwards, at the same time they do not want high pure fixed rates. They want to avoid the risk, at least for a certain portion of the loan, and some lender’s answer to such an arrangement is known as Hybrid loans.

So what are these Hybrid loans?

It is a combination of fixed and floating, also known as partly fixed and partly floating. Under this scheme, a part of your loan is locked under ‘fixed’ and the rest is under floating – the adjustable rate of interest. In fact it is supposed to be a median option between fixed and floating interest rates. This product works best for the people who are not clear about the rate movements and do not want to take the particular stance. Depending on the risk appetite and risk perception of future rate movements, you have evaluated the pros & cons of both fixed and floating but are unable to come to any conclusion. So, as per the companies, hybrid loan is another option which can work well for customers like you.

In case of hybrid loans, there are two parts to the loan agreements, one for fixed and another for floating.

That means that if you take a loan of Rs. 20 lakh and you feel that interest rates will increase, you can choose to take 60 per cent of Rs. 20 lakh as a fixed rate home loan and the remaining as floating. The proportion can change depending on your risk appetite.

In case rate moves up, you normally have an option of foreclosing your floating component of the loan with no pre-payment penalties. In case you decide to foreclose the loan locked under the fixed portion, standard pre payment penalty will apply unless you have negotiated otherwise.

Normally the company offers an option if interest rates move up, you can get the fixed portion of your floating loan into floating. You can convert the fixed component into floating by paying a conversion fee of 0.5% - 2% or as charged by your bank of the outstanding loan amount.

In the event that interest rates rise, the portion under fixed rate will be your buffer. And if they fall, then you gain on the floating component and lose on the fixed.

This product may work well for people who take large loans because they are more interested in hedging their risks. If instead of the hybrid loan, you decide to go for the fixed interest rate loan, make sure that your loan is indeed fixed for the entire duration of the loan. But lenders mostly put in a clause in some of their loans under which they reserve the right to amend the ‘fixed’ rate in the event of an ‘extreme change in money market conditions’.

Still fixed or floating dilemma has been eased out with the introduction of Teaser loans earlier this year, where interest rates are fixed for certain tenures say three years. After that option lies with you to choose either to chose fixed or floating which is 2.5% below the PLR.

Following suit, many PSU banks have come out with offers where they are offering low attractive fixed rates for the first 3-5 years (8-8.5%) with rates reverting to the standard floating rate after that period is over. These kind of loans are popularly referred to as Teaser loans where rate in the initial years is fixed as well as low. Private players HDFC and ICICI have recently joined the bandwagon. They announced a similar teaser loan product early December, 2009. Thus presenting clearly a good option for the consumers who want to stay away from tracking home loan rates at least for a certain period of time.

So what does a teaser rate home loan mean for the Indian consumer? It means that there is a low initial interest rate that is fixed for a specified period (1 year to 5 years) and the floating rate as specified becomes applicable thereafter.

Given below is an analysis of the some of the teaser rates home loans available in the market for a 20 year home loan of Rs. 30 lacs.

Home Loan interest rates for 20 years, Loan amount of Rs.30 Lakh - as on December 23, 2009

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BANK For first year Overall effective rate

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SBI Easy Home Loan **** 8 8.76

CANARA BANK *** 8 9.33

HDFC** 8.25 8.63

ICICI BANK * 8.25 9

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****SBI offers 8% fixed for the 1st yr, 8.5% fixed for the next 2 yrs, 4th yr onwards borrower has an option of choosing either floating rate which will be 2.75% below SBAR or fixed rate which will be 1.25% below SBAR. *** Canara Bank offers 8% fixed for 1 yr, 9% fixed for next 4 yrs, thereafter min. 10% for loans upto Rs 30 lakh.

**8.25% fixed till 31st March 2012, thereafter prevailing floating rate (currently 8.75%)

*8.25% fixed for 2 years , 3^rd onwards it is FRR (currently 12.75%) minus 3.50% = 12.75% -3.50% -= 9.25%

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But it is certainly not a one time decision, you need to review your decision at fixed intervals. Basically, partly fixed and partly floating interest rate loan lack interest rate transparency. The so-called fixed portion may be varied and there is no objective mechanism to ensure that floating rate floats down.

Mixed rates are normally not recommended mainly because of the non-transparency of the banks on both these (fixed & floating) rates. The risks are there even if you opt for pure fixed or pure floating, still you are not exposed to dual opaqueness.

It is advisable to use online home-loan calculators on sites like www.apnapaisa.com to estimate the Estimated Monthly Installments (EMI) for the loan amount you require. You will also need to understand the difference between Fixed-rate, floating-rate, the teaser rates or the combo (hybrid) rates to determine the rate type that is best suited for you.

Hence, it is important to evaluate all the pros & cons before making a decision in favour of hybrid loans.

The regulator (RBI) has been concerned about making credit pricing more transparent for quite some time now. One of the reasons being the wide spread complaints by home loan consumers that lenders are quick to raise BPLR when the regulator raises signalling rates (Bank rate, Repo rate, Reverse Repo rate or other rates such as CRR and SLR) but lag behind considerably when the regulator drops these rates. 

The working group constituted by the regulator for this purpose has submitted its report and RBI’s final decision is awaited. This article seeks to examine if the “Base Rate” system recommended by the group is more transparent than the existing BPLR system.

The short answer to that question is “Of course – Yes”. The Base rate system is definitely more transparent than the existing BPLR system. But there are some non-transparent aspects to the fixation of the Base Rate, which needs to be highlighted. 

In simple words the “Base Rate” system recommends that the 1-year retail fixed deposit rate of a bank (after making certain adjustments) be the Base Rate for that bank and that the floating rate loans be pegged with reference to such a Base Rate. The 1-year retail fixed deposit rate for a specific bank is easily and publicly available and to that much extent it adds considerably to transparency. It is the adjustments, however, that are based on not so easily available information as well as complex to calculate. For the adjustments the consumers will still need to depend on the concerned bank to make them properly. Having said that any bank will find it really tough to explain why the Base rate has not dropped if it decides to drop its 1-year retail fixed deposit rate.

Some other issues with this mechanism also need mention.

First, not a single bank follows the existing regulations requiring floating rate loans to be priced with reference to a suitable external benchmark. In fact, if this regulation is followed there is no need for any change in the regulation at all. This leads to justifiable concern among consumers whether any new regulations will be followed by the banks or whether the regulator will enforce any regulations that it chooses to notify in this regard.

Second, the group has left vague the applicability of the new Base system to existing borrowers by stating “ …if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the new/revised rate structure should be mutually agreed upon by the bank and the borrower.” Here everybody will agree that it is nearly impossible for a single borrower to get the bank to agree on something like this. It would have been better if the modalities of applying the new system to the existing borrowers had been spelt out clearly.

Third, of course is the enforceability of any new regulations. Any regulations to be effective needs to be monitored by the regulator and transgressions need to be penalised and repeat offenders need to be punished.

Let’s therefore hope that if the regulator chooses to accept the group’s recommendation then it will also be enforced vigorously.

Amen!

Interest rates on home loans for new consumers have come down by around 4% since September end 2008 but consumers who had the misfortune to take their loan before that have only seen their rates drop by around 1.50% – 2.25%.  

We are inundated with anguished queries from existing customers where they raise concern about this partial treatment like “I have taken a floating home loan from XXX bank in 2005. At present the interest rate I am paying is 12.5% whereas for new customers it is around 9.25%. Why this discrepancy? Isn’t there any rule that forces the banks to pass on benefits to existing consumers as well? Can I take legal recourse? “

Firstly fixation of floating rates in this manner is in direct contravention of existing RBI regulations. See this article for details of this regulation (http://blog.apnapaisa.com/2009/09/15/why-some-regulations-are-more-important-than-others/) . So your best bet is to file a complaint to the banking ombudsman about the non following of the regulations.

But if that is too slow for your tastes you as a consumer have other options as well to benefit from the drop in rates.

You too can take advantage of the drop in interest rates if you have maintained a good track record of payment with your existing lender.

As a first step, you will have to devote a bit more time on this major financial obligation than you probably have done so far.

Secondly find out what interest rates the lenders  (including your existing lenders) are offering in market for new consumers. This can easily be done from the comfort of your home or office by referring to price and feature comparison sites such as www.apnapaisa.com.

Thirdly if your existing lender is more or less in line with the market, your best bet is to make that valuable call to your existing lender to say that you want to pre-pay the loan and want a statement of overall dues so that you can make the pre-payment. Almost every single bank will offer you an option to shift to the rates that they offer to new consumers (or very close to that) on payment of a fee.  If you are the lazy type and cannot be bothered to do much more, you can accept this offer and still save significant monies over what you are currently paying. But ideally if you are of the type that wants to get the best possible deal and are willing to work for it then read on…

Before you decide to switch lenders, shop for a better deal. It is necessary to get a fair idea of the offers available from other potential lenders. Remember for these other lenders you are a new customer and they will offer their best rates to you. Approach various lenders with the intent of transferring the loan.

With new lender, the process largely resembles that of taking a new home loan. You will have to fill in an application form with the requisite details annexed with photocopies of all the property documents that you had   submitted to your existing lender. The new lender will do the legal and technical vetting of the property as well as valuation and then you will get a sanction letter from them outlining the terms and conditions of their loan to you.

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Pointers:

1.      Maintain good track record of payment

2.      Shop for the better deal

3.      Compare various deals offered by banks/ lenders

4.      Approach lenders with the intent of transferring the loan

5.      Be prepared to undergo some operational grind before the loan is taken over

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Now comes the tough operational part before you can actually start enjoying the lower interest rates from the new lender.

You will need the following letters from your existing lender:

A) Letter giving the details of the amount to be paid to completely settle the entire loan. This letter will have to mention the details like total loan amount taken, the loan amount outstanding as well as the prepayment charges, if any. The amount mentioned will be calculated as on a future date, to enable time for the buyer to arrange the payment. This letter is pretty standard and should not be too tough to get from the existing lender.

B) Letter listing all the documents held by them as security for the home loan. In most cases if you have an official receipt for the documents submitted to them at the time of disbursement then this letter may not be needed.

C) Letter from your existing lender addressed to your new lender agreeing to release the documents of title directly to them (the new lender) within a fixed number of days after receiving the full payment from them. It’s this letter that causes the issue particularly if your existing lender does not want to cooperate (after all he is loosing a good customer). There is no compulsion on your existing lender to give any such letter to a third party (your new lender) with which it has no contract. This is the letter for which you have to do a couple of rounds to your existing lenders office to get them to issue it.  

Once you get this letter from the existing lender, the new lender will make payment in favour of the existing lender to close the account and also collect the documents from the old lender.

You can then go ahead, enjoy the fruits of your labour.

A leading pink paper on Tuesday September 22, 2009 broke a story on its front page  about how RBI is planning to ban all sub-PLR loans for tenures beyond a year. The story mentioned, “If RBI bans sub-PLR rates on loans above a year, banks will find it difficult to reduce rates only for new home loan customers”.

Even this move will not end the trouble of existing home loan consumers who watch on enviously as new customers get lower and lower rates while they are stuck with higher rates. To understand this let’s look at how PLR affects home Loan consumers.

So what is this PLR? PLR stands for Prime Lending Rate or in other words the rate at which the banks will lend to their most Prime customers (customers with the best credit parameters). This way PLR should be the lowest rate at which the bank will lend.  In India lot of banks have more than 80% of their loans being lent out on rates below their PLR. This is due to non-transparency in fixing PLR making PLR itself meaningless.

Also PLR is normally supposed to apply across all loans but most Private banks have different PLRs for different products which completely send the whole concept of PLR for a toss. 

You can see the box below to see how banks can continue to charge existing consumers a higher rate than what they offer to new consumers even after SUB-PLR rates are banned.   

In fact the remedy for home loan consumers already exists in  the form of existing RBI regulations that require that all reference rates should be external and objective which is not being followed by banks. (see this link http://www.apnaloan.com/home-loan-india/some-important-regulations.html). 

So if you are an existing  Home loan customer being treated unfairly by your lender you should immeidately complain to the banking ombudsman that the bank is not following existing RBI regulations regarding transparent fixation of reference rates.

How banks will continue to charge more even after banning SUB-PLR lending?

All floating rate are linked to the movement in a reference rate. For banks in India the reference rate for floating rate loans is a particular PLR of that bank.

Let us say you took a home loan from bank A at 3% below their PLR for home loans (say called Retail PLR) when the Retail PLR was 12%. Thus the effective rate applicable to you became 9% (Retail PLR at 12% less 3%).

Now if the lending rates drop in the market to say 8% it may offer loans to new customers at 8% by increasing the spread from the Retail PLR (i.e. Retail PLR 12% less 4% = 8%). Since the Retail PLR itself has not changed, the existing customers continue to pay 9% whereas the new customer gets 8%.

How banks can continue to provide lower rates to new Home loan customers whilst charging higher rates to existing customers even after the ban on Sub-PLR loans

“In order to ensure transparency, banks should use only external or market-based rupee benchmark interest rates for pricing of their floating rate loan products. The methodology of computing the floating rates should be objective, transparent and mutually acceptable to counter parties. Banks should not offer floating rate loans linked to their own internal benchmarks or any other derived rate based on the underlying.”

No, this is not an extract from any of the Blog Posts at Apnapaisa. Rather this is a contained in a circular of the RBI dated July 1, 2006 and re-iterated faithfully in annual master circulars (which consolidate all regulations governing interest rate on advances) every year since, including on July 1, 2009. This is supposed to be binding on all banks and yet to the best of my knowledge not a single bank in the country is following this diktat. In fact it cannot be unknown to RBI that the biggest complaint on Home loans is that banks link their floating rate loan products to their internal benchmark rates only and not to any external rate. Clearly this is one RBI regulation that is not being followed.

On not following regulations let me turn to the experience of my nephew (we also incidentally share the exact same name) who wished to pay his monthly credit card bill vide a cheque. He wanted acknowledgement of the cheque deposit on the bank counter, which the branch was unwilling to give. His employee (who had taken the cheque for deposit) was brusquely informed to drop the cheque in the drop box and told in no uncertain terms that an acknowledgement was not possible. My nephew dug out a copy of the RBI circular dated April 10, 2004 wherein the RBI has clearly directed that “ …the facility for acknowledgement of the cheques at the regular collection counters should be available to customers and no branch should refuse to give the acknowledgement if the customer tenders the cheques at the counters. We agree with this recommendation and advise that it is important that there is no curtailment of the rights of the depositor to obtain an acknowledgement by going to the concerned counter. You may please advise all your branches to ensure that the above instructions are scrupulously followed and customers are not inconvenienced in this regard. “ (Emphasis added). I think anybody who has tried to get an acknowledgement from a bank counter for payment by cheque of a credit card bill will immediately empthasise with the experience of my nephew.

But let’s revert to the experience of my nephew. When even a personal visit by him to the branch did not yield any results he filed an official complaint with the bank. When that did not yield any results he filed a complaint to the banking ombudsman with a copy to the bank. Only then the bank got into action and agreed to accept and acknowledge the cheque over the counter in the future and even provided a written apology. The banking ombudsman closed the case based on this apology letter and expressed inability to announce any punitive measures to prevent such occurrence in the future. A complaint to the RBI to take punitive measures to prevent a recurrence of such action was also turned down.

The upshot is that my nephew continues to face the same problem month after month. His employees are now adept at carrying a copy of the apology letter issued earlier and on that basis getting an acknowledgement for the cheque. But it is clear that the bank is not providing the same service to any other customer who may not be as persistent as my nephew. Clearly a case where the RBI regulation is observed more in its breach.

This is not to say that RBI goes easy on the banks, which violate its regulations. In fact for regulations that are important for systemic stability even minor violations are punished with warnings and fines. That’s the main reason why our banking systems came out unscathed from the global financial tsunami, which took down with it several globally renowned banks. Even in consumer facing regulations the office of the banking ombudsman has bought significant relief to consumers.

But the real issue is that some consumer facing regulations have been bought in whose financial implication on the banks is perhaps not understood fully. For example on the acknowledgment issue, banks are quick to argue that providing a facility to acknowledge cheques across the counter is an expensive affair. That may be true but the solution lies in explaining things to the regulator to drop the regulation and meanwhile following the regulation scrupulously.

In fact on the regulation on fixation of external benchmark rates for floating rate loans – the financial impact of following this regulation is very significant – both for the banks and for the affected consumers. It would be interesting to see what will happen when an affected consumer complains to the banking ombudsman about the non-following of this regulation by the banks.

It would be interesting to see whether the regulation changes or the banks are forced to follow the existing regulation. Either ways it will have an significant impact.