Even as Housing Finance Companies (HFCs) have come under the direct supervision of the Reserve Bank of India (RBI) since August 2019, existing home loan customers are getting differential treatment from banks and HFCs.
Over the last 18 months to 5 years, if bank customers have seen better transmission of rate cuts in their home loan rates on account of cut in marginal cost of lending rate (MCLR), HFC customers have had limited benefit because of relatively smaller cuts in the prime lending rate (PLR) — something that matters a lot in a long-term product such as a 10-20-year home loan.
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How do existing home loan customers benefit from a cut in repo rate?
While HFCs and banks compete hard on rates to attract new customers, the cut in rates for existing customers depends on the reduction in MCLR by banks and in PLR by HFCs in response to a repo cut by RBI.
HFCs base their lending rates on PLR and offer a discount on it to customers. While the discount is fixed for the term of the loan, an upward or downward revision in PLR (in line with repo rate movement) impacts the lending rate of the existing customer. As for new customers, the HFC can increase the discount on the PLR to offer a more attractive rate. A cut in PLR is reflected in the effective rate for the customer within three months.
In the case of banks, lending rates are based on either MCLR or on the repo rate (since October 2019). When RBI cuts the repo rate, the customer (on the MCLR base) will see a fall in her effective rate only if the bank lowers its MCLR. For new customers, banks could reduce their spread over MCLR to offer an attractive rate. In case the loan is benchmarked against 1-year MCLR, if the bank revises its MCLR, it will reflect in the effective rate of the customer only at the end of the year.
Beginning October 1, 2019, RBI introduced the external benchmarking system to replace the MCLR for home loans and other loans. This new lending rate system is only applicable for loans with floating interest rates. Banks are now offering external benchmark-linked loans that are connected to repo rate, Government of India treasury bills, etc.
How have rates moved for HFCs and banks?
Since October 1, 2019, the repo rate has come down by 140 basis points from 5.4% to 4%, but the transmission in lending rates has been varied. While the leading banks have brought their MCLR down by around 110-115 basis points, leading HFCs reduced their PLR by roughly 80 bps in the same period. But an HFC like LIC Housing Finance has not touched its PLR in the same period — it continues to be 14.7% as in October 2019. This means that an existing LICHF customer (who did not pay a conversion fee) would have received no benefit of the 140-basis-point-cut in repo rate during this period.
In fact, over the last 5 years, while existing home loan customers of leading banks would have seen a decline in their rates by around 190-220 bps on account of cut in the MCLR, HFC customers would have seen a decline of only around 25-30 bps.
The cuts in MCLR and PLR have been on account of sharp cuts in repo rate. Between April 1, 2016 and March 31, 2021, the RBI reduced the repo rate by 275 bps from 6.75% to 4%. RBI has in the past raised concerns over transmission of repo cut in lending rates of banks on outstanding loans.
How do HFCs keep their rates competitive for new customers?
While there is a large gap between banks and HFCs when it comes to passing the benefit of a repo rate cut to existing borrowers, large HFCs compete with banks and offer similar rates to new customers.
As HFC rates are benchmarked to PLR, they increase the discount on PLR for new customers. But since existing customers only see a decline in their rates when the PLR is reduced, they do not benefit when the HFC increases the discount on PLR for new customers.
So, if you took a home loan in 2017 and the PLR then was 16%, if the HFC offered a discount of 7%, your effective rate would have been 9%. But once you are on board, your rates would go down only when the HFC reduced its PLR.
However, for new customers, as the RBI cuts the repo rate, the HFC cuts its rate by increasing the discount on PLR. A new customer taking a loan in 2018 would have got a higher discount of say 7.5%, thus bringing his effective rate at 8.5% (assuming no change in PLR).
While both HFCs and banks offer the facility of switching to rates being offered to new customers after payment of conversion charge, a reduction in their PLR/MCLR would directly benefit borrowers. Existing customers often keep paying rates upwards of 9%, even though market rates on home loans have fallen below 7%.
What should existing customers do?
The transmission of rates for existing floating rate home loan customers is not very transparent. Existing customers should keep an eye on the rates they are paying, and compare them with the rates that the bank or HFC is offering to new customers. If there is a difference, they should convert their loans to lower rates after paying conversion charges, which vary from institution to institution.
When you pay the conversion fee, the bank/HFC revises the spread on your PLR/MCLR in sync with what it is offering to new customers. This will, however, also depend on your CIBIL score.
This is how it may work: Suppose you have a principal outstanding of Rs 30 lakh on an ongoing home loan, and the remaining tenure is 15 years (180 months). At an interest rate of 8%, you would be paying an EMI of Rs 28,669. However, if by paying a conversion fee, you can bring the interest rate down to 7.3%, you can either reduce your loan term by 13 months or bring down your EMI by Rs 1,200.
Customers with a good CIBIL score (of above 700) should bargain for the lowest possible rates. For a customer with a home loan of up to Rs 30 lakh, the objective should be to get a rate closer to 6.8%, which is most competitive at present.
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