A decade and a half ago, commercial banks led by the State Bank of India (SBI) aggressively expanded into the home loan market, a segment where housing finance companies (HFCs) such as the HDFC would rule the roost. Unlike HFCs, banks had an advantage of low cost funds to play the interest rate game. They used it to the maximum, running the home loan business like a commodity business in terms of bigger scale, rock-bottom interest rates and lower margins. The HFCs put up a good fight by serving the segments neglected by the banks and by offering different variants of products. In fact, the commercial banks also came under the regulator's radar for not passing on lower interest rates to borrowers. In fact, banks were quite quick in transferring any rise in the cost of funds via repo rate borrowing to borrowers, at the same time, they were slow at transferring any reduction in the repo rate.
Over the last decade, the RBI introduced new benchmarks such as Prime Lending Rate (PLR), base rate and marginal cost of fund-based lending rate (MCLR) for better transmission of interest rates. None of them gave desired results. The RBI has now mandated banks to offer repo-linked lending rate, which is expected to bring uniformity in interest rates and help in faster transmission.
Meanwhile, the State Bank of India (SBI) Chief Rajnish Kumar has sought clarity from the RBI whether India's largest bank can offer 'fixed-floating' home loan product, that is, offering long-term home loan at a fixed rate for the first few years followed by a repo-linked floating interest rate. Kumar's comments don't make it clear if he meant a teaser kind of loan product where the loan is fixed at an interest rate lower than floating interest rate in the first few years to lure borrowers or it wants to offer them a fixed rate higher than the floating rate. In the past, the SBI had offered a teaser loan that the RBI did not encourage.
Kumar's idea of a fixed-floating rate is to protect the margins as transmission could be very fast in a repo-linked lending. In a falling interest rate regime, it would hit the margins and reduce the flexibility at maintaining higher margins by not transferring the benefit of lower interest rates.
Under the new regime of repo-linked borrowing, there will be an option for banks to offer loans at fixed interest rate for the full tenure, say 15 years or 20 years. Currently, the private sector Axis Bank has a fixed home loan product at 12 per cent interest rate for 20 years. Many banks don't offer long-term fixed loans as their liabilities or deposits are short-term in nature. Long-term assets with short-term liabilities increase the risk of asset liability mismatches in a rising interest rate scenario over the tenure of the loan. In the past, there were banks and institutions that offered fixed loan products with a clause hidden in the loan agreement that in case of extreme money-market conditions of interest rate volatility, the bank had the discretion to revise the interest rates under a fixed loan.
The repo-linked borrowings give rise to a regulatory arbitrage as NBFCs have been offering a fixed cum floating rate products. Banks can market such products by earning a fee if these get popular among people.
Currently, the biggest non-bank home loan company HDFC offers fixed home loan interest rates for first two years. It offers a home loan up to Rs 30 lakh to borrowers other than women at a rate of 8.75 per cent for two years. The interest rate for loans between Rs 30.01 lakh to Rs 75 lakhs is 9.05 per cent. Similarly, the interest rate for loans between Rs 75.01 lakh and above is 9.10 per cent. Another NBFC Can Fin Home has a home loan product called Super where interest rate is fixed for a period of first three years, after which floating rates apply. The fixed rate for first three years is between 10.75 to 13.25 per cent for salaried and professionals.
From borrower's perspective, there could be a case for going in for a fixed rate for initial few years, as they know the outgo every month. In fact, the repo rate has gone down to a decade low of 5.40 per cent. Given the threat of imported inflation and higher fiscal deficit, interest rates may start to go up again. In addition, over a longer period (say for 10, 15 or 20 years), there are always interest rate cycles. That said, locking your loan for 15-20 years at a fixed rate makes sense in the current scenario.