If you have taken a floating rate loan and are proud of your decision, you might want to re-think the decision. Fact is that the floating rate loan is just a fiddle that banks are playing to make money at your expense.
Your floating rate loan is not really floating. Don't believe us? Read on. . .
Banks and housing finance companies lavishly claim that a floating rate loan is a sure shot winner to get the benefit of a falling interest rate scenario. But going by the way banks are phrasing their home loan agreements, there appears to be little truth in that claim.
If you find that hard to believe, listen to what Pawan Singh, a professional from Bangalore has to say. Three years ago, Singh took a home loan to buy a flat, and opted for a floating rate. This was what his bank officials recommended.
"I was told that a floating rate of interest for the loan was a better option because of the falling interest rates," he says. Singh, who had seen interest rates in the market falling, assumed that his number of installments would also go down.
However, when he went to review the status of his loan last month, he discovered to his horror that the number of installments had actually gone up. "This sounded atrocious to me," he says.
A visit to the bank soon brought out the reason - a small but significant clause about 'spreads' that Singh missed when he took the loan. This clause, hidden in the fine print of the loan agreement, turned out to be the real killer.
Hidden clause on 'Spread'
Banks don't draw attention to this clause, but Moneycontrol brings you the real story.
Spread is the difference between the PLR (prime lending rate) and the home loan interest rate. When you opt for a floating rate, you may be assuming that you will pay less when interest rates fall. But your floating rate is not really benchmarked to current home loan interest rates, it is linked to the "spread". And this spread does not always change every time interest rates fall.
Let's take the example of few leading banks. In the case of HDFC, the PLR came down from 11.5% in January 2002 to 9.75% in July 2003. It increased to 10.25% in November 2004. HDFC officials say that spreads during this period increased from 1% to around 3%.
So for someone who took a floating rate loan in July 2003 at a spread of 1% to PLR, his effective interest rate would have been 8.75%. But someone who took a loan say in July 2004, may have got a spread of 2% and hence paid only 7.75% interest.
Similar is the case with other banks. In case of State Bank of India, currently, the benchmark rate is 10.75% and the floating rate of interest is between 8% and 8.75%. The current spread is therefore between 2% and 2.25%. The spread in 2002 was 100 bps.
In case of ICICI Bank, the present Floating Reference Rate (FRR), which is the benchmark rate, is 8.75% and loans are offered at a spread of 75 bps. Earlier, the spread was 50 bps.
Coming back to Singh's case -- the spread was 75 bps and the PLR was 10.25% three years ago when he took the loan. The same bank today offers a spread of 2.25-3% on a PLR of 10.75%.
When Singh demanded an explanation from bank officials, they told him that as per the agreement, the floating rate is linked only to changes in PLR. Hence the bank was not liable to give the benefit of changes in the spread to its existing customers. So if the bank's PLR is 10.75% now, Singh will pay an interest of 10%, while a new customer will pay at 7-7.75%.
While most bankers say that the benefit of floating rate is passed on to all customers, what they don't tell you is that this benefit is passed on disproportionately. New customers get a bigger benefit than old customers because they have a bigger spread.
Standard Chartered says, "Our customers have always benefited in a downward interest rate regime. In fact we have always ensured that the best rates are offered to our existing customers besides offering various service discounts to customers based on their relationship with the bank."
But when Moneycontrol asked the bank how many times it had revised rates downwards for past customers, there was no direct answer.
ICICI Bank says, "Our FRR has been changed five times since April 2002. It has been reduced four times, and increased only once." But what is the extent of benefit for existing customers?
"Since the decrease has been four times, while FRR has increased only once, most of the customers have benefited by opting for floating rate loans," the bank said.
Most banks appeared to tell us the same story. To get an independent view, Moneycontrol spoke to Harsh Roongta, CEO of Apnaloan.com. Roongta confirmed that 'spread' was indeed the clause that was misleading.
He also explained, "Floating rates in India are not transparent. A benchmark rate must ideally be an external, market related rate, which is not in control of two parties to the contract. Ironically, however, in India, the benchmark is a PLR, which is a particular banks' internal rate. What should instead be widely used is an external rate."
So, what lending institutions announce as falling interest rates holds true only for new customers. For someone who has already entered a floating rate agreement with the institution, the interest rate will be linked only to the changes in PLR.
As P K Rath, GM, Marketing of LIC Housing Finance puts it, "If the bank has not reduced its PLR, the borrower's rate of interest will not be revised as his rate of interest is linked to PLR. The bank may offer fresh loans at rate of interest of 7-7.50%, which may be at substantial discount to PLR. But this will benefit new customers only."
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