The Hindu Business Line : When floating rates turn fixed in home loans

Most opt for the floating rate, for they perceive that the marginal drop in interest rate announced by the bank every now and then, would be passed on to them. But are they really reaping the benefit when banks announce a rate cut?

While the concept and understanding of the floating rate suggest that the benefit of the reduction announced by the bank is automatically passed on to the existing customers who had opted for it, in reality it is not happening. A closer study of the issue will show that these banks, instead of charging a uniform rate to all its existing customers (particularly those who had opted for the floating rate), choose to pass on the benefit only to prospective customers.

Bankers reason that it would be impossible to pass on the benefit to the existing customers in full as their operating margin is under severe pressure.

Citing an example, the official explained: X could have availed the loan at say 12 per cent (a couple of years back) when the deposit rate was hovering at around 10 per cent. Subsequently, the rates took a beating. Two years ago (in 2002) some of the banks offered to revise the rate to the prevailing rates (then) if the borrower was willing to pay a processing fee of one per cent on the outstanding amount. But you must understand that the rate of interest is linked to the prime lending rate (PLR).

"Some paid the one per cent processing charge and managed to get a lower rate," he said.

But whenever an announcement of a reduction in the interest rate is made, banks reduce it without reducing the PLR.

For instance, if a bank's PLR is 10 per cent and say a customer is sanctioned a loan at one per cent (100 basis points) below PLR, it means that he is charged at 9 per cent. Subsequently, the bank announces a cut in the home loan rate, making it available for 7.5 per cent. (Note: there is no mention of a revision in the PLR). The banks instead of reducing the PLR simply say 2.5 per cent (250 basis points) below PLR and offer at 7.5 per cent to the new and prospective customers. Since the PLR remained unchanged, the existing customers, who had opted for the floating rate, do not get the benefit of the reduction in the interest rate. They continue to be charged at 9 per cent.

If one looks back, one would notice that the interest rate on home loans had fallen by close to 5 per cent (500 basis points) in the last four years. But the PLR (of a few banks) had been slashed by just one per cent (100 basis points). This has facilitated new borrowers to avail of home loans at reduced rates, while the existing customers, who had opted for floating rate could manage to get a reduction of one per cent only.

That is not all. If a customer decided to switch over to another bank to avail of a better rate by foreclosing his loan account, he is required to pay a penalty of 2 per cent (200 basis points) on the balance outstanding in his account, thus neutralising and discouraging such attempts.

While banks are engaged in rate war to bring more customers within their fold, customers too have started to watch the rate movement, either to switch over to another bank that offer a better rateor go for a loan from a bank that gives the best rate.

Home loan takeovers have not been uncommon. While banks appear keen to take over loans of prompt repayers, the imposition of a charge on foreclosure of the loan has made the borrower think twice about a switch over.

Alleging that the practice resorted to by the banks as `unethical and unfair', the Coimbatore Consumer Cause has suggested a review of the situation, so that both the existing and prospective borrowers enjoy the benefit of a reduction in the interest rate.

It's Vice-President, Mr M. Govindarao, said that this practice created two sets of customers in banks - the existing ones, who even after opting for floating rate end up paying a higher rate and the new ones enjoying the advantage of the reduced rate.

"In effect, the home loan borrower who opts for a floating rate ends up paying at a `fixed-floating' rate.

"Why should banks offer a floating rate at all," he asked.

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