A home loan borrower, who had availed a Rs 1 crore loan under the teaser loan scheme that was popular a couple of years before, from a housing finance company (HFC), was in for a shock when he tried to prepay it. He was told he would have to pay a penalty of Rs 2 lakh as prepayment charges since the funds were not his own.
A circular issued by the National Housing Bank (NHB) in April says loans given under special rate schemes (carrying a fixed rate in the initial period followed by floating rate like the State Bank of India's famous teaser loans) should be treated as fixed rate loans. And, according to NHB's guidelines, prepaying (through another loan or borrowed funds) fixed rate loans involves a penalty.
The circular relates only to teaser loans and not dual rate loans, said R V Verma, chairman, NHB. Teaser loans are those offered at significantly lower rates for the initial loan period (two-three years) and then converted to higher rates, usually floating rates, for the remaining period.
Dual rate loans charge a fixed rate of interest for the initial period and then floating rate. However, NHB is in the process of collecting data and information from HFCs, and will issue a fresh circular clarifying the clause, Verma said. “We received complaints from borrowers, which is another reason we are reviewing the situation,'' he said.
According to NHB guidelines, there is no prepayment penalty on floating rate loans, irrespective of the source of funds used for prepayment. But for fixed rate loans, there is a penalty if the funds are borrowed from some other source, that is, if it is refinanced. For teaser loans, lenders can charge a penalty for prepayment if it is refinanced, similar to fixed rate loans. Reason: The loan was charged at a fixed rate of interest at the time of approval, the NHB circular said. HFCs are required to make an additional provision of two per cent for these loans as they carry interest rate risk as well as some credit risk.
"The borrowers get the benefit of lower interest rate during the initial years of the loan for some time. HFCs are required to make additional provision. This additional provision has to continue for at least one year from the change to floating rate. That is why once the loan moves to floating rates, there has to be some balance to ensure the viability of the loan (both on individual as well as aggregate level) and the system. Besides the interest rate risk, there are other inherent risks in the teaser loan products, such as the asset-liability mismatch, and even potential default risk. These have to be factored into the business model, in the larger interest of viability and sustainability,'' Verma said.
According to Vipul Patel of Home Loan Advisors, an independent mortgage advisor, borrowers who feel they are stuck with such loans should negotiate with their lender. Usually with persuasion, financial institutions may agree to reset the interest rate once the borrower has moved to a floating rate. That is, they can shift to a lower or current market rate after paying a certain fee.
“When the rate changes from the fixed rate to the floating rate and the monthly repayment remains unchanged then, the tenure goes up substantially. And as the difference between floating and fixed rate is 1-1.50 per cent (current floating rates is 10.5-11 per cent and fixed rate 12.5 per cent), it is natural teaser loan borrowers would want to move to another institution for a near market rate,” Patel said. If the rate goes up by two per cent in 24 months, the tenure can go up from 20 to 40-42 years, say industry experts.
The fixed rates offered by various banks and institutions under the teaser schemes were benchmarked against the then existing system of benchmark prime lending rate or prime lending rate. The lending rates offered were at a discount to the prime lending rate (PLR) or benchmark prime lending rate (BPLR)
Over the past two to three years most BPLR/PLRs-linked home loan rates have moved to over 12.50 per cent. The home loan rates then were at a discount of one per cent to 1.5 per cent. Hence, when the fixed rate tenure for teaser schemes ends and floating starts, borrowers saw or may see a jump of at least one per cent, depending on their mark-up over the BPLR/PLR defined at the time of loan approval.
An official from an HFC said if the lender allows conversion (reset rate), then it makes sense for the customer to opt for it rather than refinance it. “Those who move to a new lender will require to pay a processing fee. So, customers must also look at the benefits they get from their own lender before going in for refinance,'' he said.