Interest rates have been rising ever since this year began. Even during 2007, there were continuous fluctuations in the interest rates of home loans.
Another development that took place was banks offering lower interest rates on housing loans to new customers.
To deal with the hike in interest rates and get the benefit of reduced rates (which were for floating rate loans exclusively at one point in time!), most consumers decided to pay off the loans with existing banks and transfer loans to banks offering cheaper loans…
All’s well till this point. What happens when one transfers a home loan from one bank to the other is that certain charges are payable, one of which is the prepayment penalty. Banks charge this fee to compensate for the loss of their income from the loan. The question here is, is it justified?
To me, personally, it is very unfair of the bank to charge a penalty to a consumer who is just trying to save his money. For one, most banks do not reduce interest rates for existing consumers; the newer ones are known to get lower deals. So, the option left for such a loan consumer is to transfer the loan. Other consumers may opt for a loan transfer because they think that their lender is charging higher rates as compared to the other lenders in the market. In both the cases, it does not seem fair on the part of the bank to charge a prepayment penalty.
But, to look at it from the bank’s point of view, the charge of the penalty seems completely justified.
July 1st, 2008 at 1:42 pm
I disagree with the author’s conclusion. You have taken a partial view of this topic.
http://www.indianbank.in/homeloan.htm
Indian Bank clearly states that if you are transferring the loan, we charge 2%, otherwise there is no penalty. This makes sense. Complete sense.
Secondly how many people transfer their loans from one bank to another bank and at what cost is this.
You have a processing fee for the new loan and you have to run from pillar-to-post and not to forget the tension involved in this entire thing to make this happen. Again statistics and numbers will make sense, writing without facts and figures and making arbitrary statements do not make sense.
Regards,
Subramanian
July 2nd, 2008 at 1:47 pm
While the comment is appeciated and of course, you may continue to disagree-the view is taken based on facts and figures which stare at you in the eye. While it seems justified for the bank to increase interest rates in the view of the fact that it is business, it is but fair for the customer to be able to switch lenders should he find himself in a disadvantageus situation. And not to forget the fact, Sir, consumers are any ways running pillar-to-post most often than not to pay the increased EMIs or to put it crudely-to make ends meet.
With due respect to your opinion, I would request you to go in for a reality check. When you call it a baised view, I really wonder what the word means to you. It seems to me that for you the basic instinct of survival seems to be a challenge. Sure, the hapless consumers keeps paying higher rates (for whatever reason on the earth!).Please be kind enough to expain the term ‘otherwise’ used by the bank you have mentioned and its possible sources!
July 3rd, 2008 at 3:44 pm
Interesting response.
I need to clarify a few things :
a) When I say “You have taken a partial view of this topic”, I do not mean you are view is partial to any side. I mean you have taken only part of the information and discussed this.
b) Your blog title - is prepayment justified ? Your final statement or take is from the bank’s point of view , this is justified and your comment states otherwise. I am confused here. What are you trying to convey ?
Secondly, if you have some statistics like 1 out of every 100 persons change banks for difference in interest rates with details that include they incur a cost of say 1,00,000 Rs for every time they switch from one bank to another. Facts and figures are needed to bolster your argument on any sides.
I think I will take one more step backwards here, you have not even said why is it from bank’s point of view, the pre-payment penalty charge justified ?
To me the bank is making a huge mistake here. Penny wise , pound foolish.
They have huge non-performing assets , lot of people who don’t pay and the money is extracted from the people who pay the EMI regularly and wants to give the entire principal amount back as soon as possible. Yes, they lose the interest but the consumer has already paid the principal. They have go t their money back. So why charge a prepayment penalty and a service tax(that just takes the cake !).
I think this blog does not do justice to the many points that arises on both sides. As a consumer, I definitely can add many more points why the bank shouldn’t charge !
Regards,
Subramanian V.
July 3rd, 2008 at 4:39 pm
Yes, there will and are of course more reasons than one can count for why banks should not charge a prepayment penalty, and to forget the service tax charged. Also, the very reason why most people do not often transfer the loans is extra charges such as prepayment. This is what is taken up here, in the small space I have utilized. I am simply trying, not to take sides…that’s the title of the bog…it’s a question left in the air.
Coming to my statement about the bank charging the fee, it does cost them a whole lot (such as NPA’s) in terms of business when they increase the interest rates. It would be a nice to know if you have an answer to how does a bank deal with the fact that the funds it can are becoming even more costlier, the CRR or the repo rate hike?
You also seem to have left a question answered, which was a part of your earlier comment. When you cited the Indian Bank terms on loan prepayment, you mentioned the term otherwise. You have not answered that bit. What the otherwise means to me is ‘surplus cash’….I find it hard to believe that someone will have surplus cash to foreclose a loan in such times as today when inflation is high and so are interest rates.
I am sorry to have confused you, but I clearly stated that ‘Personally, I find the levy of a prepayment penalty unjustified’.
July 3rd, 2008 at 5:55 pm
What you surmise as ‘otherwise’ is completely right ! It is surplus cash. I presumed the website makes it amply clear. Apologies for my presumption. Since you say , you find it hard to believe, you are taking personal experiences here. In fact, I find it hard to believe, why will people not have surplus cash. But again, it is a personal perspective. Therefore, at the risk of repeating myself, I reiterate that facts and figures will make more sense here.
I don’t know a single person who is not able to find surplus cash to prepay. We all have 20 year home-loans and we know with the calculation with 20 year time periods the interest amount is more than the principal amount and therefore we strive to pay more of our debt as soon as possible. The idea of leading a debt-free life makes so much more sense.
The reason why it is hard to believe is (again generalising here) people tend to splurge on unwanted things and do not try to lead a thrifty life. You don’t have to be a miser but one should know the do’s and don’ts when you have a home loan hanging as a Damocles sword.
I would love to explain this but may I request you to rephrase these statements:
a) It would be a nice to know if you have an answer to how does a bank deal with the fact that the funds it can are becoming even more costlier, the CRR or the repo rate hike?
b) Coming to my statement about the bank charging the fee, it does cost them a whole lot (such as NPA’s) in terms of business when they increase the interest rates.
I am not sure what you mean. How does NPA and bank charging the fee related ?
From your previous comment it is heartening to know that you and I are against the bank charging a penalty for prepayment. However, it may not be right to assume that people don’t have surplus cash to repay their loans.
One of the plausible reasons is :
a) They are investing the same money elsewhere anticipating a higher return on investment
Equity market, real-estate, foreign exchange, rentals, business etc.. - all these elements are risky but one who is willing to take the risk is sometimes awarded with higher returns. Let us not venture into the area why one shouldn’t go into the above areas as it drives us into the irrelevant tangents.
Regards,
Subramanian V.
July 16th, 2008 at 5:01 pm
Just saw this very interesting debate. So first let me give the bank’s side as to why the pre-payment charges are justified:
1) Pre-payment charges are an universal phenomenon in home loans and any other long term loans. The bank borrows money on certain terms and then onlend them to consumers on certain terms. When the consumer pre-pays the loan the bank now has cash that it has not planned for. It is possible that if the bank seeks to pay back the amount to its lenders it may itself also have to pay a pre-payment charge (which obviously it needs to recoiver from the customer). In any case there are treasury charges that are incured for handling this unexpeceted cash which is recovered through pre-payment charges.
2)There are several upfront charges that the lender incurs at the incpetion of the loan agreement that is recovered over the period of the loan by way of an increase in interest rate. Any pre-payment short circuits this recovery and thuis needs to be paid for.
Having said all that here are the arguments against banks charging pre-payment penalty on floating rate loans :
1) In India it is a fact that existing consumers pay a higher rate than the rate offered by the same lender to a new consumer with absolutely the same credit profile.This is due to the absence of any regulation in thsi regard. Almost all banks includuing public sector banks ahve done this in the past. This practise (it is a market practise) considerably reduces the force of the logic that banks use for charging a pre-payment charge
2) Some banks offer no repayment charges provided the repayment is made from “own sources”. How this will be verified is not clear and hence again sometimes gives rise to local level disputes from branches that are under pressure to maiantain profitable assets on their books.
To summarise I would say that in the current rising interest rate scenario the justification for charging a pre-payment penalty is much weaker than usual.