A new client mentioned the loss on a mutual fund investment of Rs 15 lakh. He had made systematic investments in equity mutual funds, acting on the advice of his previous financial advisor. While going through his profile, we noticed he also had a home loan of Rs 75 lakh which he had taken about three years ago. Apart from knowing his monthly EMI (equated monthly instalment) which was Rs 74,000, he had no idea about his loan amount due, as well as the interest he was paying on it.
However, he vaguely remembered the lender had increased interest rates. A little digging showed the interest rate he was now paying was 12 per cent and the reason he wasn't aware of this was the lender had kept his EMI the same, while increasing the tenure of the loan. This was an investor who had consulted a financial advisor and checked his mutual fund return statements. He was dissatisfied with the performance of his mutual fund portfolio (the reason why he approached us). It was, therefore, a shock that such an investor was totally oblivious to the cost he was paying for his home loan. Acting on our advice, he spoke to his lender and secured substantial reduction in the rate without any cost or major effort.
But it set me thinking. Investment is an activity that makes you a more active participant in the process. This might be missing even though you could be paying an enormous percentage of your monthly income as EMI on your home loan. As long as the amount does not change, you are oblivious to the cost, despite being vaguely aware you are paying more than what you should be.
Do you know the interest rate you are paying on your home loan? Believe me, very few people (mostly those who have just taken the loan) know the actual interest rate they pay on home loans. When the same question was asked to a group of mutual fund investors who invested through systematic investment plans (SIP), a significantly high number were aware of the returns they were getting. So, there is a strange dichotomy between SIP investments and loans, though in both cases, the instalment is debited from bank accounts automatically every month. Perhaps, what leads to this is the voluntary nature of SIP payments (which can be stopped at any time, without any penalty), as well as the fact that the interest rate is not visible in the EMI. There is no immediate pain when the interest rate on your home loan is raised, as the EMI remains the same. You tend to ignore the communication (letter / email / SMS) you receive informing you of the increase in interest rate (now mandatory, according to regulations).
Banks started the practice of increasing (I keep saying 'increasing' rather than 'changing' simply because very few consumers have actually seen the benefit of a reduction in tenure when interest rates drop) tenure, rather than EMI for practical considerations, as repayments are made by post-dated cheques and securing fresh post -dated cheques as replacements for the old cheques is a Herculean and expensive task. When the repayment mode shifted to ECS (electronic clearing system), the practice continued.
In the past, whenever banks have been forced to increase EMIs due to rapid increases in interest rates (despite the costs involved), they have seen increased consumer activity to shift loans to cheaper lenders. And, it is better when consumers shift their loans to competition. Both the regulators (the Reserve Bank of India and the National Housing Bank) have officially acknowledged the pernicious market practice of Indian lenders to charge higher rates to existing home loan consumers, while providing lower rates to new ones.
The regulators were forced by public opinion to ban pre-payment charges to provide some respite, at least to more aware and active consumers. Now, they can do more by mandating a change in the default option when interest rates of the lenders change - the default option should be to change the EMI amount due to the change in interest rates. This is good for lenders, too, as tenures wouldn't stretch (thereby, increasing credit risk for the lender) and as consumers sign the ECS mandate for larger limits, they are likely to be sensitised to the fact that EMIs could increase as interest rates rise. Of course, consumers can talk to lenders and revert to keeping the EMIs the same, with a change in the tenure. And, if the rates are reduced, they would actually see more cash in their hands because of reduced EMIs.
Do you agree changing the default methodology is a good idea? I await your comments.
The writer is CEO of Apnapaisa