On 1 December, India’s leading private sector mortgage lenders ICICI Bank Ltd and HDFC Ltd decided not to extend their special home loan scheme, known as teaser loans in common parlance, beyond 30 November. Teaser loans offer a low fixed rate of interest in the first few years after which the loan floats as per the lender’s benchmark rate (base rate for banks and benchmark prime lending rate for housing finance companies).
Corporation Bank, too, discontinued teaser rates some time back and other banks are expected to follow suit. Should you view the end of these loans as a missed chance or a regime of which you shouldn’t have been a part. We try to understand what teaser rates means and whether they work for you.
The move gains significance given that the Reserve Bank of India (RBI), in its last policy review meeting last month, had expressed concerns over these loans. In fact, RBI has been uncomfortable with banks offering teaser loans for some time and recent events that shook the housing finance market have brought matters to a head.
One reason is the fact that the loans are attractive in the initial years due to low fixed rates, but could shock consumers out of comfort once the equated monthly instalments (EMI) go up along with the floating rates. In November, RBI had said: “This practice raises concern as some borrowers may find it difficult to service the loans once the normal interest rate, which is higher than the rate applicable in the initial years, becomes effective.”
Let’s take an example of a teaser loan of Rs30 lakh, which offers a fixed rate of 8% per annum in the first year, a fixed rate of 9% per annum in the second and floating rate, thereafter, for 15 years. The EMI in the first year, at 8%, would be Rs28,714. In the second at 9%, the EMI would go up to Rs30,391, an increase of Rs1,677. After that, if the rate firms up at 11%, your EMI will shoot up to Rs33,699, an increase of Rs4,985 from the first year. And if you are already stretching to pay the EMIs in the initial years, you may not be able to bear the extra burden in the subsequent years.
Says Alpana Killawala, chief general manager, department of communication, RBI, “In teaser loans, the lenders may be assessing the borrowers creditworthiness for the discounted rate. We do not know if the borrower is also assessed for the creditworthiness at the future applicable rate which may be significantly higher.”
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Benefits not so huge for construction-linked loan
The benefits in a teaser loan are not as huge as they sound if you’ve bought an under-construction property and taken the construction-linked option. When you buy a property under construction, you typically get two options—to pay the builder upfront or in tranches linked to the progress of the construction work.
In the lump sum payment plan, the teaser loan is beneficial. Says a senior private sector bank officer, who did not want to be named since his bank does not offer a teaser loan: “Frankly speaking, when there is a single disbursement, a teaser loan will work, since you pay low interest on the entire amount.”
But that’s not the case with the construction-linked payment plan. Under this plan, the loan gets disbursed to the developer at various stages of construction and the entire disbursement may take at least a couple of years or more.
This means you will get a low interest rate only on a part of the total loan amount and, therefore, the benefit is limited. Says Satkam Divya, chief executive officer and managing director, Rupeetalk.com, “Interest is charged on the amount which is disbursed.”
A senior officer working with State Bank of India, who is not permitted to speak to the media, says, “Typically, the interest is charged on the loan outstanding amount. So the interest is applicable only to the amount which has been disbursed.”
In the example taken earlier, in the first year, if 10% of the loan amount (Rs30 lakh) is disbursed, you will pay 8% interest only on Rs3 lakh. In the second year if another 10% were to be disbursed, you would pay 9% only on Rs6 lakh. By the time, the entire amount is disbursed, the rate would become linked to the benchmark rate of the bank.
Says Adhil Shetty, chief executive officer, Bankbazaar.com, a loan portal, “Since teaser is cheaper only in the first two years, there is less benefit for those who have a longer disbursement schedule.”
Cases of project delays are not uncommon even if you opt for reputed developers. Delay in construction would mean, delay in disbursements and less low-rate benefit. Says K.V.S. Manian, group head (consumer banking), Kotak Mahindra Bank Ltd, “One should look at the overall rate of interest and also see the period of discount (low interest rate). Therefore, take a long-term view and look at the rate at the subsequent years and also access the period of development (of the property).”
Significantly, most people are known to opt for the construction-linked plan, possibly to minimize the risk of the developer in terms of delivery timelines and other issues. Says Shetty, “We ran numbers for the last six months and saw that one-third of the loans were taken as full disbursements and two-thirds were partial disbursements, depending on the construction progress. Typically, there were two to six disbursements (over the entire course of construction).”
However, some experts argue that there is benefit in a teaser loan, even if it is for a less period of time. Says Harsh Roongta, chief executive officer, Apnapaisa.com, a loan portal, “Teaser loans give a low interest rate for the initial few years. If you are aware of the loan details and can take care of the EMIs, it works.”
“Another option in case you have a longer disbursement schedule is taking a loan offering a fixed rate for five years fixed and then going on to floating rates. But these are not exactly teaser loans,” says Roongta. The advantage here is that you will be able to avail the benefit of low fixed rates for a longer period of time.
Problem for banks
RBI has hiked interest rates six times since January; this has raised the cost of funds for financial institutions. Also, with the apex bank raising the provisioning norms for housing loans in its last policy review, banks need to keep aside 2% of the loan value compared with 0.4% earlier. These issues have made mortgage lending costlier for banks and teaser loans may not be a sustainable option to offer.
Says Anil Sachidanand, chief executive officer, Dewan Housing Finance Ltd: “The regulator has come down heavily on such loans (teaser). The market has not evolved yet and (hence lenders) should not experiment with such products.”
With two major banks signalling the end of teaser rates the only options left will be a floater or a fixed-rate loan. Our advice is to go for a floater that has a low base rate and a small mark up on that base rate.