The Reserve Bank of India (RBI) has raised the repo rate by 25 basis points (bps) each in two of the last three monetary policy reviews. While the rising interest rate means gains for bank depositors, it also means higher interest for the loan customers. Repayment of big-ticket loans like home loans also becomes costlier. In such a situation, what should you do if you are out in the market for a home loan? Also, should an existing home loan customer look for a switch to a lower rate loan from another lender?
Before we get into that, let’s understand what is happening in the credit market. According to a Kotak Institutional Equities report, one year MCLR rates have risen 25 bps since June 2018 and 35 bps since March 2018 on average. The first rate hike by the RBI from 6.0% to 6.25% happened in June. “MCLR rates were flat month on month in October 2018 for PSU and private banks at 8.7% and 9.3% respectively. With deposit rates broadly stable, a swift rise in MCLR rates is less likely,” the report said. That being said, the rates have indeed risen and the rise has been sharper in private banks. Housing finance companies (HFCs) too have raised their home loan rates.
PSU, Private banks and HFCs
The marginal cost of funds based lending rate or MCLR is based on the cost of funds for banks. The source of funds is either deposits by the customers or market borrowings. The private sector banks normally offer a relatively higher deposit rate compared to their peers in the public sector. “People are ready to deposit in public sector banks at a relatively lower rate because of the belief of people in public sector banks as well as the government backing. So, as the deposit rate for private banks is relatively higher, when translated into MCLR, that also becomes relatively higher,” said Asutosh Mishra, head of research, institutional equity, Ashika Stock Broking.
At the same time, the credit growth is coming to the private sector banks. So to support this growth, the private banks have to raise deposits or borrowings from the market, for which they have to offer a premium. Hence, the cycle of credit growth leading to higher deposit rates leading to higher MCLR for private sector banks will continue.
While public and private sector banks are the first options, many home buyers have also been availing of home loans from HFCs. Over the past few years, HFCs have been gaining market share in the home loan segment. From a share of 33% in March 2012, the share of NBFCs and HFCs has gone up to 39% in March 2018. The overall size of the market has also expanded and almost doubled from ₹8.3 trillion in March 2014 to an estimated ₹16 trillion in 2017-18, according to Crisil Research.
Over these years, a new segment of borrowers of self-employed and a new class of affordable housing has emerged, said Supreeta Nijjar, vice president and sector head, Financial Sector Ratings at ICRA Ltd. “These categories were being experimented and largely being served by HFCs, which was an expansion in market. The NBFCs and HFCs were targeting the niche categories that were being addressed by very few banks, which is why they were growing at a faster pace,” she said.
What you should do
So if you are looking for a new home loan, it might be a good idea to consider public sector banks first, said Melvin Joseph, a Sebi-registered investment adviser and founder, Finvin Financial Planners. “I prefer PSU banks, especially SBI for a home loan. They are quite fast and transparent in responding to rate changes. The flip side is that their documentation is quite complex. But the complex documentation can also be taken as a positive factor as they will do a proper due diligence about the property and the titles before releasing the loan,” he said.
The MCLR is the lowest rate at which a bank offers a loan. For home loans, banks charge a spread over the MCLR rate, depending upon the risk profile of the customer. Some banks also offer the loan at MCLR rate itself to customers with a good credit profile. So, this could be your chance to take benefit of a good credit score and negotiate for the lowest possible rate.
If the person plans to clear-off the loan in the next 4-5 years, there is no point in switching if the rates are very competitive- Melvin Joseph, Founder, Finvin Financial planners
When interest rates go up, banks and HFCs typically let the equated monthly instalment remain the same and instead increase the loan tenure. The borrower is intimated about the change in rates. A longer loan tenure would mean higher interest outgo.
Moreover, your interest rate will be reset based on whether your home loan is linked to 6-month or 1-year MCLR. For instance, if your loan is linked to 1-year MCLR and the reset date is in November, your rate of interest will be locked till November next year at the rate prevalent in November this year.
So you may not meet with a hike in interest rate just yet, but you may always find that a bank is offering home loan at a cheaper rate and you may be tempted to switch, anticipating an eventual hike in the current home loan. Moreover, it is also possible that you took a loan from a housing finance company at a higher rate earlier and over the years, your credit profile has improved.
Even in such a situation, you might want to consider switching the loan to a lower rate from a public or private sector bank. So what should existing home loan customers do if the interest rate on your home loan has gone up and another bank is offering a lower rate?
Before you make that transfer, be sure about the costs involved. In such a situation, if the difference between the existing and the new rate is above 50 bps, and the remaining repayment period is longer, say over 10 years, only then should you consider switching your home loan. “If the person plans to clear-off the loan in the next 4-5 years, there is no point in switching the loan if the rates are very competitive. Also, in case of a switch, you will have to study the costs in transferring the loan,” said Joseph.
If your savings over the years will be higher than the transfer cost, then making the switch may make sense. Moreover, the cost of transfer has to be paid immediately, whereas the saving will be spread over years.
If you have a good credit profile, you can even negotiate with the bank and get a waiver on some of the charges like processing fees or administrative fees. For the floating interest home loans, there is no prepayment penalty by the current lender.
The market is abuzz with rate hikes and it is natural for you to worry. But it’s always better to evaluate the costs, and as said earlier, only if the gap is more than 50 bps and you have a long tenor to pay the home loan, should you make that switch.