Home loan in India

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.