Zero prepayment fee not enough to ensure fair deal for borrowers

The Reserve Bank of India (RBI) in its first bimonthly monetary policy statement 'suggested' the zero pre-prepayment charges regime for floating rate home loans be extended to all floating rate loans (that is, car, loan against property, business loans, SME loans and so on). Consumer protection is an integral aspect of financial inclusion.

This is a welcome step, since Indian borrowers have been charged high interest rates through a unique form of floating rates by all lenders (whether public or private sector). These floating rates promptly rise when market interest rates rise but refuse to float downwards when the benchmark rates drop. Prepayment penalty is a financial penalty that discourages consumers from shifting their loan to another lender which would charge less. There is no earthly reason why this financial penalty should be allowed to be levied for other loans where borrowers suffer the same discrimination as housing loan borrowers.

By disallowing a penalty to be levied when consumers switch their loans to another lender, a financial barrier is removed that makes it easier for the consumer to switch loans and keep the practise of discriminatory rates between new and old borrowers in check. But lenders are adept at creating non-financial barriers as well.

Ask any borrower who has tried to switch his home loan from one lender to another. The new lender has to make payment to the existing lender without having the security of the property papers in their hands. The existing lender releases the property documents a few days after the full payment is received by them and the new lender is essentially lending on an unsecured basis till that time. The new lender naturally seeks confirmation from the existing lender about the documents kept as security with the old lender, as well as a confirmation that they will be handed over directly to them (the new lender) once they make the pre-decided payment.

The existing lender is most uncooperative, since they are losing a good consumer and the whole process is more painful than getting teeth extracted without anaesthesia. Only a very determined consumer is able to cross this non-financial barrier, a big reason why transfer of home loans is still not widespread, despite the high level of discrimination faced by existing borrowers.

RBI should ensure a sector-wide mechanism that standardises the documents and processes for transfer of documents directly between lenders and lays down pre-defined time limit for such transfer cases. This mechanism should be uniform and extend to all banks, non-banking finance companies and housing finance companies for it to be really useful.

Without a push from the regulator, the lenders are unlikely to come out with such a scheme. This single step will ensure consumers don't have to run from pillar to post to get a fair deal. Coupled with the removal of penalty on shifting of loans, it will be a formidable check on lenders preventing them from overcharging existing borrowers. Incidentally such a scheme not only helps borrowers looking to shift their loans to another lender, but it also helps those buying premises (or any other assets) which have been mortgaged/hypothecated with a lender, since they can use the same mechanism.

If you agree that this kind of document transfer mechanism is important to enable borrowers to get a fair deal, you should write to RBI (use the 'contact us' section on www.rbi.org.in) providing them this suggestion.

The write is CEO, Apnapaisa.com