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Over the past few weeks, leading financial institutions - State Bank of India (SBI), HDFC Bank, ICICI Bank, Bajaj Finance and HDFC Ltd -have hiked deposit rates, signalling to harden of interest rate regime. 

As the financial institutions are dragging their feet to raise the lending rates, it is time for customers to choose between a bank and a Housing Finance Company (HFC) before taking loans for their dream homes. 

Home loans: Bank vs HFCs

Post Reserve Bank of India’s (RBI) guidelines effective Oct 2019, floating-rate bank home loans need to be linked to an external benchmark like repo rate. The objective behind the new loan regime was to ensure the transmission of rate-cut benefits to the borrowers. In other words, borrowers of home loans from banks would see changes in their applicable loan interest rate with the movement in the repo rate (at which the RBI lends money to banks and financial institutions).On the other hand, for HFCs home loan interest rates are pegged to their prime lending rates (PLR) which are linked to their own cost of funds.

Banks determine the home loan rates by charging a mark-up to the repo rate while HFCs offer loans after giving discounts from their PLRs. For example: if a customer chooses to take a home loan of 50 lakh for 20 years from a large nationalized bank, she may get it at 6.7% ( 4% of repo rate + 2.70% of margin charged by the bank). In case, she prefers to take the same amount of loan with the same tenure from a large HFC, she may end up agreeing on an interest rate of 6.70% (16.05% of PLR – 9.35% of discount). Both the bank and the HFC offer a similar rate of interest at the entry-level. However, there is a strong possibility of the customer ending up paying more to the HFC, compared to the bank, over a period simply because the transmission of benefit arising out of changes in the RBI’s key policy rate will be more for the loans taken from banks. At least, that is what we have seen in the past few years.

Comparison of interest rate transmission:

 

 

Month

PLR for HFC

MCLR for Bank

Nov-17

16.15

7.95

Nov-18

16.75

8.50

Nov-19

16.85

8.00

Nov-20

16.40

7.00

Nov-21

16.05

7.00

 

Let us assume that customer A has taken a home loan of 50 lakh for 20 years from a large HFC at 9% in November 2017. This HFC offered him the interest of 9% when its PLR was 16.15%. It meant, the HFC offered a discount of 7.15% from its PLR of 16.15%.

Another customer B has taken the same amount of loan with same tenure from a large bank at the same 9% interest as the bank charged him a mark-up of 1.05% over its MCLR of 7.95%. 

Both of them agreed to pay an EMI of Rs. 44,986.30

Impact on tenure 

Month

HFC

Bank

Nov-17

240

240

Nov-18

258

255

Nov-19

252

221

Nov-20

220

182

Nov-21

197

170

 

Referring to the above table, it shows that the customers with banks benefitted much more than their peers who availed loans from HFCs. This is because bank loans are linked to external benchmarks. Four years after taking a loan from a bank, customer B saves 27 EMIs (amounting to 12.14 lakh) compared to customer A who had taken a loan from an HFC.

As a home loan is a long-term commitment, borrowers should make an informed decision while selecting a lender. 

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