Is Base rate making floating rate loans transparent & HOW?

“Mr. Earlier and Mr. Later are twin brothers who work in the same company, on the same post and on the same salary. All their other assets are same except that Mr. Earlier decided to buy a Flat in July 2010 and approached a bank to get a,home loan,for Rs. 30 lacs to part finance the acquisition. He got a good offer where the rates remained at a fixed rate for 3 years and post that the applicable rate was the bank’s Base rate plus 1.75%.

His twin brother Mr. Later decided to buy the flat adjacent to his twin brother’s flat but he was pleasantly surprised to find out that after the initial period the rate applicable to him would be Base rate plus 1.50% only as against his twin brother Mr. Earlier who would be paying Base Rate plus 1.75%. Clearly Mr. Later was reaping the benefit of being a new customer since there was clearly no difference in his credit profile vis  his twin brother and the underlying asset provided as a collateral security was of the same value.
This just goes to prove the old adage that more things change, the more they remain the same. Clearly the new Base Rate system as currently implemented still leaves a lot to be desired in terms of imparting transparency to floating rate,loan,pricing. Firstly, although the methodology for fixation of Base Rate was supposed to be transparent, but not a single bank (to our knowledge) has yet disclosed the formula by which it has calculated its Base Rate. Almost all banks have revised their Base rates upwards in the last quarter and more increases are expected in the current quarter. Again no information is available whether the banks have been following the same methodology as their earlier calculations and the increase is only due to increase in the benchmark rate used by them or they have changed the basis of calculation as well. (They are allowed to do so till June 30, 2011).
Floating Rate option for Loan Amount 30 Lacs and
20 years tenure

Lender

July 2010

January 2011

Base Rate

Spread

Effective Rate

Base Rate

Spread

Effective Rate

ICICI Bank

Initial Rate

Fixed till March 2012

8.25

1.25

9.50

April 2012 onwards

7.50

1.50

9.00

SBI

1st year

Fixed for 3 years

Concessional Floating Rate

2 “ 3 years

4th year onwards

7.50

1.75

9.25

8.00

1.50

9.50

The only saving grace is that the Base rate system is probably better than the erstwhile BPLR system where the BPLR had become a completely meaningless rate used by the banks only to make the existing customers pay higher interest. When interest rates fall in the market (yes they will fall at some point of time though it looks a little distant as of now) the banks will be forced to reduce the Base rates to some extent (unlike the BPLR) because the bank will be unable to lend below the Base Rate and the corporate borrowers are not going to accept an high interest rate arising from an inflated Base Rate.

If all this discussion makes your head spin, you can take certain measures to safeguard your interest.
If you are looking for a home loan for the first time and have to choose from among various floating rate,loans,:,a) Choose a lender who lends on the Base Rate system (which means banks and not housing finance companies since the Base Rate system does not apply to HFCs) and,b) Between two lenders who offer you the same effective rate, choose the Bank that offers you a lower spread above Base Rate. For example if Bank A is offering you a home loan at 1.50% above its base rate (which is currently say 8.50%)  effective rate  10% and another bank say B offering you a Loan at 0.50% above its base rate (which is say currently 9.50% and hence effective interest rate is the same 10%) then choose bank B. The reason Bank B is more advantageous is that when interest rates in the market drop, there will be more pressure on Bank B to reduce its Base Rate which is quite high relative to Bank A. So paradoxically if the effective rate is the same you should choose the bank with a higher Base Rate.

If you are on the old BPLR system, and currently having a period during which the interest rates are fixed, then:,i. Ask the lender to shift you to the base rate system, just avoid the time your fixed rate period gets over,ii. If the lender does not have the Base rate system wait until the fixed rate period is over before deciding what to do with the Loan,iii. If you are currently paying a variable rate, the chances are that you are paying a much higher rate than is warranted. Either ask your existing lender to drop your rate and if he does not agree shift your loan to another lender. Follow the guidelines in a) above to choose your new lender.
Clearly there is no substitute for vigilance.
So act in time to get the deal which you rightfully deserve!

 

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