The Competition Commission of India, a statutory body whose role is to promote competition and protect interest of consumers, in December ruled that banks and housing finance companies are justified in levying prepayment penalty on foreclosure of home loans.
Despite the ruling, all is not lost for home loan customers who want to prepay. In fact there are ways through which one can avoid prepayment penalty.
The Commission, while passing the judgement, observed that there is no reason to believe that customers do not have enough choice available. Apart from various private sector banks, 43 housing finance companies (HFCs), 27 public sector banks, 53 cooperative banks provide home loan and their prepayment penalty rates vary.
The Commission also considered growth in home loan market between 2003-04 and 2008-09 when the industry reported a compounded annual growth rate of 24.9% to conclude that prepayment charges have not caused any negative impact on the home loan market.
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Banks and HFCs justify levying prepayment penalty as they believe it is needed to maintain a balance between deposits and credit and such charges provide certainty about the cash flow. Defending prepayment charges, some HFCs argue that even the National Housing Bank (NHB), the regulator of housing finance companies, charges prepayment penalty if they decide to prepay their liabilities earlier than stipulated time frame.
“It is not that we arbitrarily impose prepayment penalty. The provision of prepayment penalty is specifically mentioned in the loan documents signed by home loan borrowers and it is not a breach of trust on our part,” said Albert Tauro, chairman and managing director, Vijaya Bank.
The general practice
Prepayment charges vary from lender to lender and there is no uniform practice. While some banks such as Axis Bank Ltd and IDBI Bank Ltd, do not levy any prepayment penalty, some levy such penalty only if another bank is taking over the loan. However, the rest levy such charges irrespective of the source of fund. Usually, the penalty varies between 1% and 5%.
“In many cases, prepayment penalty depends on the time frame. Higher the time frame, lower the charges,” said Kartik Jhaveri, founder and director, Transcend Consulting, a Mumbai-based financial planning and wealth management firm.
The silver lining
In a guideline issued in 2010, NHB prohibited HFCs from charging prepayment penalty in case a borrower is pre-closing the home loan from his own source.
“There might be some initial glitches but overall the compliance of the guidelines has been very good. Since November till date, close to 13,000 home loans have been pre-closed without being charged any penalty,” said R.V. Verma, chairman and managing director, NHB.
The grey areas
Most lenders levy prepayment penalty only if a home loan borrower is pre-closing the loan with borrowed money. But, in practice things are not as simple. The onus of proving that the fund used to pre-close a loan is not borrowed from any other lender lies with the borrower. Says Verma, “If home loan borrowers wish to pre-close their loan without having to pay any penalty, they need to prove that funds are out of their own resources. Even if someone has borrowed from one of their relatives, it would be considered their own fund.”
According to financial planners, the easiest way to prove that the fund belongs to you is a bank account statement.
Says Surya Bhatia, certified financial planner and principal consultant, Asset Managers, “In many cases borrowers have multiple accounts and someone looking for a pre-closure of home loan should ideally have bank statements of all their accounts with them. Ideally, the bank account statement should be of six months duration.”
In circumstances when someone borrows from their near and dear ones, they (borrowers) should ideally do so through cheques. It will make the job of proving the source of funds easier. Also, having bank account statements of relatives from whom you borrow can be helpful. “If someone redeems his/her investments to pre-close home loan, he/she should keep the redemption letter to prove the same,” added Bhatia.
What should you do?
If you fail to prove the origin of the fund, you should insist the lender for a one-on-one discussion. “We receive a lot of complaints from borrowers regarding the sources of fund. While borrowers invariably insist that the fund belongs to them, lenders refuse to buy the argument in absence of any proof. In such circumstances, we suggest both the lenders as well as customers to discuss and sort out the issue,” said Verma.
“Ever since the time we have issued the new guidelines on the same, the number of complaints has reduced substantially,” added Verma without disclosing the number of complaints received after the issuance of the new guidelines.
However, there is a better way out. “Every lender has the power to waive certain penalties including prepayment penalty. It depends upon the negotiating ability of the customer,” said Jhaveri.
Also, look for lenders who do not charge prepayment penalty provided interest rate charged by them is not too high compared with peers. “Interest rates hold the key. If the difference is not substantial, it makes sense to opt for a lender who does not penalize for prepayment,” said Ashish Kapur, chief executive officer of Invest Shoppe Pvt. Ltd, a Delhi-based wealth management and advisory firm.
There are other factors besides interest differential to be kept in mind. One should only transfer loan to another lender if a repayment tenor of 10-15 years is still left. Else considering average prepayment penalty of 2%, gains will be negligible.
Illustration by Shyamal Banerjee/Mint