Floating rate home loan (at least in india, since that's where my experience lies) is a grossly misused concept. I have taken 4 different home loans in the last 5 years, and have learnt a few useful lessons.
All banks have a benchmark lending rate (BLR), this has slightly different names in different banks, but the concept is the same. When you apply for a floating rate home loan, they give you a discount over the BLR, and will try to woo you by giving the lowest possible effective rate (BLR - discount) in the market. But, this is just a ploy to lock you in and exploit you for the rest of the loan tenure.
The BLR is a complete sham and the banks have complete independence in how to manipulate it. You will realize this when the interest rates in the market start to fall below the level that you got your initial loan at. The reasonable expectation is that your effective rate should fall as well (after all that's what you thought "floating" meant). But, lo and behold, nothing like that happens. When you ask the bank, you'll find out that the BLR of the bank has not nudged at all. You then wonder how the bank is staying competitive in the market!! Well, it's quite simple, they have simply increased the "discount" for the new customers, so that they can rope in new customers by giving "floating rate" loans at competitive terms without passing on the benefit to existing customers.
You would then think that things will probably even out when the interest rate in the market rises. But, no such luck. The banks are very prompt in hiking the BLR as soon as the interest rates rise, making sure they don't miss a rupee in revenues.
To quote a couple of specific examples. I saw this with a home loan I took from ICICI bank. The initial rate of interest was 11%. This gradually rose to 13.5% and stayed there even when the prevailing market rate of interest was more like 10%. I asked ICICI bank to adjust my floating rate to reasonable levels, but they didn't do it, and eventually I moved my loan to a different bank at an interest rate of 9.5%, after paying a 2% pre-payment penalty to ICICI.
I saw it again with Deutsche Postbank (formerly BHW). I got a loan in 2008 at an extremely competitive rate of 9.99%. Today, 2 years later, my loan rate stands at 10.49%, when the bank is openly offering new loans at 9%. Even after raising this with them, and even escalating it to senior levels, there has been no remedy. And if i want to move my loan to another bank, I need to pay up 2% pre-payment penalty, which makes the whole exercise worthless.
That brings us to the pre-payment penalty clause. This clause is specifically in place to ensure that the banks can hold you ransom even when they are not giving you a fair deal. You can't even transfer your loan without paying this penalty.
Another sham that the banks have come up with to cover their ass in this scenario is a scheme to reduce your loan rate by paying an upfront fees. They typically charge you 1-2% of your loan amount to reduce the loan rate by 0.5-1%. This means it will take you more than 2 years to just recover the upfront fees that you paid them to lower the rate. And I'm pretty sure, 2 years later you will find yourself in the same position again. Not really a solution to the problem.
Btw, RBI has proposed some guidelines whereby the BLR would be regulated and such exploitation can be prevented. I'm not sure when that comes into effect, but it's really required to stop the banks from continuing to exploit gullible customers.
Moral of the story: When you take a floating rate loan, try to ensure that there is no pre-payment penalty clause, because that's the only way you can avoid being exploited (by moving your loan to a different bank) if the bank keep hiking your effective loan rate.
I should also put in a word here for a couple of banks with which i had good experience. HDFC bank was very fair, and even allowed me to close my loan early without any penalties. Axis bank offered me a loan without the pre-payment penalty clause, and have been pretty prompt in reducing my loan rate in response to a reduction in market rate.
Disclaimer: I have no personal bias towards any of the banks mentioned in this article. I have just recounted actual facts.
Friday, May 21, 2010
Wednesday, May 19, 2010
White collar crooks (aka Wealth managers)
Watch out for the so called wealth management services offered by the banks. Your relationship manager from the bank will offer to do this for you. I often wonder how qualified these guys really are, they do seem to be smart guys and girls with MBA degrees, so I would assume they do understand what wealth management means.
I have obliged plenty of these wealth managers during my last 3 years of experience in dealing with banks and researching information about investments in general. But, not one of them has come close to helping me "manage" my "wealth". All that they are interested in is peddling schemes and offers that result in big fat commissions for them. And they don't hesitate in brazenly lying about the "features" of the scheme that they are selling. These are your white-collar crooks. I am amazed at how they twist facts with a straight face.
Here's one example that I have overheard plenty of times. A new fund offer (NFO) from a mutual fund company is a good buy because the NAV at lauch is only Rs 10. Anyone with a little understanding of mutual funds would know that NAV of a mutual fund means nothing. The only purpose of NAV is to determine the number of units that you own and track the relative performance of the fund over time. Whether the NAV of a NFO is Rs 10, or Rs 100, or Rs 3.1416 is hardly relevant. In fact, common sense tells me that it is generally not a good idea to invest in a mutual fund of an NFO becuase they will probably be incurring much more initial costs (advertising, initial setup etc), which will come from the money that you are going to invest in it. Moreover, unlike an existing fund, there is no past data to judge how well the fund could perform. So, for all you know it may turn out to be a dud. Compare that with a mutual fund that has been around for 5 years, and has consistently delivered superior returns year-on-year. Why on earth would you prefer the NFO over the existing established fund (unless of course, the NFO has completely different goals which you believe in, and there is no existing fund doing that)?
But, the wealth managers will still pitch you every NFO that comes out for the simple reason that they have incentives to sell that which they don't have with the existing mutual funds. With the entry loads abolished, selling existing mutual funds is not lucrative at all.
Another common misleading pitch is about the ULIPs. They will tell you that the policies come with a lock-in period of only 3 years, and you can get your money after that. They very conveniently fail to mention the penalties incurred if you do that instead of continuing the policy for the full term of 10 or 15 years. Also, they very conveniently gloss over the fact that the fees charged in the first 3 years are much higher and the average fees charged comes even close to reasonable only if you at the entire policy period of 10-15 years. Moreover, they will tell you that you can easily get returns of 15% because these are linked to equities, without sharing with you the inherent risks of investing in equities over short periods of time. ULIPs may be reasonable investment avenues for at least a 10 year horizon (even though the fees are high, and should be rationalized further), but to pitch them as 3 year instruments is a crime.
One such rogue convinced my father to convert a fixed deposit (prematurely) into a ULIP policy. How can a ULIP be a replacement for a 1 year FD as an investment goal? I think such guys should be hanged to set an example. While-collar crooks!!!
I have obliged plenty of these wealth managers during my last 3 years of experience in dealing with banks and researching information about investments in general. But, not one of them has come close to helping me "manage" my "wealth". All that they are interested in is peddling schemes and offers that result in big fat commissions for them. And they don't hesitate in brazenly lying about the "features" of the scheme that they are selling. These are your white-collar crooks. I am amazed at how they twist facts with a straight face.
Here's one example that I have overheard plenty of times. A new fund offer (NFO) from a mutual fund company is a good buy because the NAV at lauch is only Rs 10. Anyone with a little understanding of mutual funds would know that NAV of a mutual fund means nothing. The only purpose of NAV is to determine the number of units that you own and track the relative performance of the fund over time. Whether the NAV of a NFO is Rs 10, or Rs 100, or Rs 3.1416 is hardly relevant. In fact, common sense tells me that it is generally not a good idea to invest in a mutual fund of an NFO becuase they will probably be incurring much more initial costs (advertising, initial setup etc), which will come from the money that you are going to invest in it. Moreover, unlike an existing fund, there is no past data to judge how well the fund could perform. So, for all you know it may turn out to be a dud. Compare that with a mutual fund that has been around for 5 years, and has consistently delivered superior returns year-on-year. Why on earth would you prefer the NFO over the existing established fund (unless of course, the NFO has completely different goals which you believe in, and there is no existing fund doing that)?
But, the wealth managers will still pitch you every NFO that comes out for the simple reason that they have incentives to sell that which they don't have with the existing mutual funds. With the entry loads abolished, selling existing mutual funds is not lucrative at all.
Another common misleading pitch is about the ULIPs. They will tell you that the policies come with a lock-in period of only 3 years, and you can get your money after that. They very conveniently fail to mention the penalties incurred if you do that instead of continuing the policy for the full term of 10 or 15 years. Also, they very conveniently gloss over the fact that the fees charged in the first 3 years are much higher and the average fees charged comes even close to reasonable only if you at the entire policy period of 10-15 years. Moreover, they will tell you that you can easily get returns of 15% because these are linked to equities, without sharing with you the inherent risks of investing in equities over short periods of time. ULIPs may be reasonable investment avenues for at least a 10 year horizon (even though the fees are high, and should be rationalized further), but to pitch them as 3 year instruments is a crime.
One such rogue convinced my father to convert a fixed deposit (prematurely) into a ULIP policy. How can a ULIP be a replacement for a 1 year FD as an investment goal? I think such guys should be hanged to set an example. While-collar crooks!!!
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