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Home Loan @ 9.25% It's Magic

Public-sector banks have introduced home loans with interest rates as low as 9.25 per cent.

Harsh Roongta

18 Dec 2008

The home loan package announced by the Public sector banks yesterday reminded one of a stage magician's show where he hands over money that has miraculously appeared from thin air, to a member of the audience. In similar circumstances the central government has "prevailed upon" the public sector banks to announce this home loan package. No doubt the deal is excellent for consumers seeking home loans between Rs. 5 lacs+ upto Rs. 20 lakh - a fixed interest rate (for 5 years) of 9.25% and nil processing and pre-payment fees and free life insurance to boot. So where is the catch?


Before we look at the catch let's see the impact of this magic.


Loans up to Rs. 20 lakh mean properties costing up to Rs. 25 lakh (after taking into account the margin money of around Rs. 5 lacs). These kind of flats are just not available in the super metros like Mumbai, Delhi and Bangalore except in the far flung suburbs. Off course with the property price correction the tier II and tier III cities will have such properties available. The significant reduction in interest rates is likely to result in some increase in demand for such properties. It's unlikely to result in a huge upsurge of demand simply because demand for properties is not driven by interest rates alone. Notwithstanding some corrections, property prices in popular areas continue to be unaffordable and we are unlikely to see new demand emerging till the prices reach some kind of equilibrium. So the number of consumers who will take advantage of this package is unlikely to be very high.


Now let's turn to the catch.


Where will the money come from (we are now too old to believe the magician can actually make money appear on its own) and more importantly how much money will be available on the package? The banks do not really make any money on offering such a package and in fact may loose money on any such package. There is not a word on who is going to bear the cost of such a package. After all even the PSU banks are commercial organizations which are required to earn a fair return on their depositors and shareholders fund (and a lot of PSU banks have significant non government share holding). Clearly on this package they are not earning such returns (on a marginal cost basis they will be earning negative returns notwithstanding the convoluted calculations based on average cost of funding). What this means is that the profit made on existing borrowers (home loans as well as non retail borrowers) is being used to subsidise the new consumers. This is quite unfair. I think it is about time that existing loan consumers shake off their inertia and assert themselves. They should shift their loans from lenders who charge them more while giving lower rates to new consumers. This is the only way to ensure that your existing lenders do not take you for granted.


If the demand, contrary to expectation, was to pick up for loans under the package then the PSU banks will seek to limit the amount lent out under the package by imposing strict conditions. We have already seen that happening in education loans. education loans are high risk lending products and hence naturally the banks look at higher returns to compensate for the high risk. However there is a ceiling on interest rates at 1% above the bank's PLR which means that the banks are unable to price their education loans at a price which it would make money for them. Due to the government push they are unable to get out of the business. As a result they seek to limit the people to whom such loans are given by asking for collateral security and/or guarantee from people earning substantial incomes. This is not possible for a majority of loan seekers as a result of which they are unable to benefit form the subsidized education loan scheme. In the end it becomes available only to the upper middle classes and the rich who are not the intended beneficiaries of the subsidized loan schemes. So ironically a well intentioned move to limit the interest rates results in the loan itself not being available to the very people to whom it is intended to benefit. The fear is that something similar will happen to this home loan 'package' should the demand be high.


Secondly, the package is valid only till June 30, 2009. It is difficult to foresee how so many residential units will be available for disbursement by that time even if the package has the intended effect of increasing demand. Obviously the government wants to leave this issue for the new government to solve (elections are due in May 2009).


So what can be done? The government needs to put its money where its mouth is. If it wishes to subsidise the cost of loans it should create a fund that will assist the banks to reduce the rate of interest rather than expecting the banks to pay for the subsidy themselves. It should be available on a transparent basis to all banks (not just public sector banks) so that all sections of consumers can benefit with low rates as may be applicable to their credit profiles.


Till this happens this will turn into a feel good scheme with off course the limited number of consumers who decide to (and are eligible to) take advantage of the reduced interest rates benefiting from it.