In the ocean of disagreement about India’s economic indicators—gross domestic product growth, inflation, share prices—there is an island of consensus: the direction of interest rates. “Going up” are the words on everyone’s lips. The governor of the Reserve Bank of India pithily stated: “The direction of policy is clear—we had to ease at the time of the crisis, we have to tighten now.”
While the average Indian will get indirectly affected in many ways by rising interest rates, there is one area where the impact will be direct. And severe. This is in home loans.
I asked one of my senior colleagues, Francis D’souza (name changed), about the home loan that he had taken from a respected private sector institution (Francis is a chartered accountant, all the more surprising!).
“What was the kind of home loan product that you took?” I asked.
“Well, they only had one standard product, a floating-rate loan that was priced off their PLR (prime lending rate). The choice of tenor was flexible—I took a 10-year loan, since I am already 48 years old.”
“So you got a your credit score, which resulted in a discount to their PLR, and this EMI (equated monthly instalment) was for 120 months?” I asked.
“Yes, that’s right.”
“And what happens now, if interest rates go up? How do you get to know, and what impact will it have on your EMI?”
“The loan document said that the PLR gets adjusted every quarter, and it’s apparently on their website, but frankly, I don’t get any communication on it at all. But yes, if the rates go up, I will be affected—the EMI will remain the same, but I will have to pay more than 120 instalments, maybe 130 or so, depending on many factors that I don’t understand.”
“When you took the loan, was there any discussion about this exposure? And also, did you have any alternative—say, a fixed-rate home loan—that was discussed with you?”
“No, the floating-rate loan was their only product, and no, there was no discussion about the exposure that I had to moving interest rates.” He paused, and added, laughing nervously, “Frankly, I don’t look at the statements, we just hope that we will be done in 120 months!”
Francis’ situation is similar to hundreds of thousands of Indians who have taken out floating-rate home loans over the past several years. The home mortgage business today is around Rs2 trillion, growing at 35-40% a year, according to data from the National Housing Bank. Precise data on fixed/floating mix is not available, but Adhil Shetty of BankBazaar.com tells me that “over 90% of it will be floating-rate-based. Banks don’t market fixed-rate products, and sales people are generally trained to sell floating-rate home loans”.
A detailed check of the market suggests that most banks offer only floating-rate home loans, and a few offer hybrid fixed products. There are no pure fixed- rate loans—one large public sector bank offers a fixed-rate loan for 20 years, but it resets after five years.
Many market observers have written about how India’s mortgage market is unfair to customers. But these debates have invariably been about one particular issue—that of the arbitrary and subjective nature of PLR setting by each individual bank.
However, the fixed versus floating exposure issue has received little attention. Some argue that this is because there is no demand for fixed-rate mortgages—customers invariably choose to pay a few per cent less for floating-rate loans.
But this issue cannot be dismissed as one of informed choice and caveat emptor. There are two critical aspects that need attention: One, the deeper systemic issue underlying the absence of fixed-rate home loans; and two, the issue of consumer rights and financial literacy.
Current market practice clearly proves that banks have no incentive to sell fixed-rate home loans. But they don’t do this because there is no deep long-maturity debt market in India that allows banks to offset their duration exposure. Essentially, the banking system has no way to offset the risk of long-dated assets on their balance sheet.
The solution? Pass on this risk to the customer. In essence, what a sophisticated banking industry cannot manage is now being handed off to the man on the street. There’s something wrong here. In the medium term, the answer will clearly come from a deepening capital market, one that can absorb longer dated assets such as home loans.
This brings us to the second point—while deeper markets and so on will take time, banking practice needs to change right away: to educate customers about the implications of their choices, and the extent of the exposure. EMI calculators can easily have “what-if” scenarios going out over the life of the loan.
In the meantime, my message to Francis was: “Please get in touch with your loan officer and understand your exposure. Don’t rest on the hope that ‘all is well’.”
Ramesh Ramanathan is co-founder, Janaagraha. Möbius Strip, much like its mathematical origins, blurs boundaries. It is about the continuum between the state, market and our society. We welcome your comments at email@example.com