Paying EMIs on a Home Loan? Track Interest Rate Changes

I came across an interesting case in a business daily a few weeks back.  A consumer forum bench directed ICICI Bank to pay Rs 55,000 to a borrower. Here is how this happened.

The borrower signed up for a home loan of Rs 30 lacs for 10 years from ICICI Bank in 2006. The loan was a floating rate loan. The interest rate at the time of loan sanction was 9.25%. The EMI was Rs 38,410. He paid the EMIs diligently for the next 10 years and more. He thought the EMIs would stop after 10 years. That didn’t happen. The bank continued to debit EMIs even after 10 years. Apparently, he noticed this after paying 136 EMIs (instead of scheduled 120 EMIs). Even after 136 months, he had repaid only Rs 17.93 lacs of principal. About Rs 12 lacs of principal still needed to be paid. This shocked the borrower.

How Could This Happen?

The loan was a floating rate home loan. As the interest rates went up, his loan interest rate would have gone up too. With the rising interest rate, a higher portion (as compared to original amortization schedule) goes towards interest payment and a lower portion (as compared to original amortization schedule) goes towards principal repayment. Hence, the principal repayment is slowed down. The banks, in the event of rate hikes, usually keep the EMIs same and extend the loan tenure.

I have discussed repayments of reducing balance loans in detail in this post.

To give you perspective, if you have taken a Rs 50 lacs loan for 20 years at 9% p.a., your EMI would have been Rs. 44,986. However, if the interest rate was right away changed to 10% p.a. and EMI kept the same, you would still have an outstanding loan amount of Rs 24.79 lacs after 20 years.

In this particular ICICI Bank case, the rate went up from 9.25% p.a. to a whopping 14.85% p.a. during the term of the loan. For this reason, principal repayment was slowed down and loan tenure was automatically extended.

Now, the Bigger Issue

How did the loan interest rate go up from 9.25% to 14.85% p.a.? Even though his was a floating rate loan, 14.85% p.a. is still very high. You can get unsecured loans at this rate of interest. And we are talking about a home loan here.

In 2006, Prime Lending Rate (PLR) regime was in force. In 2010, base rate regime was introduced. In 2016, MCLR came into the picture. In 2019, MCLR has been replaced by an external benchmark linked rate.  Whenever a new benchmark methodology is introduced, all fresh loans must be linked to the new benchmark. For the loans linked to older benchmarks, the loans are not automatically linked to the new benchmark. The borrowers can approach the banks to shift to the new benchmark if they think they will get a better deal. And therein lies the problem.

When a new benchmark is introduced, the borrowers on the older benchmark get a very poor treatment. The interest rates for the loans (linked to older benchmarks) are not revised downward as frequently. This Money Life article considers this issue in great detail. We must understand one of the reasons why the Reserve Bank has kept changing benchmarks all these years because the borrowers got unfair treatment at the hands of the banks. The banks are quick to hike loan interest rates (when the rates in the economy are going up) but are not very keen to cut loan rates (when the rates in the economy are going down).

You must consider this from the bank’s perspective too. If the borrower has not yet approached the bank to migrate to the new interest rate (and possibly lower interest rate) regime, he is likely clueless about this. If someone is happily paying 14% per annum while the same loan is available at 9% p.a., the bank would not want to change the status quo. Make hay while the sun shines.

Where Is the Bone of Contention?

The borrower has not contested that his was a floating rate loan. His contention was that he was not informed of the interest rate hikes as per the loan agreement. His queries to the bank went unanswered. He approached the district consumer forum. The bench noted that the bank claimed to have sent intimations for the rate hikes but could not produce documentary evidence in this regard. For this failure on bank’s part, the bench directed ICICI Bank to pay Rs 55,000 to the borrower.

There is no reason why the borrower will be satisfied with such an award. He has lost much more due to higher interest rate.  By the way, even with respect to this award of Rs 55,000, I wouldn’t be surprised if the bank challenges this in a higher forum or the court.

What Is the Learning?

Take interest in your finances. While it is stupid to keep thinking about money all the time, it pays to take some interest about your finances. It is your money after all.

While my trust in the banks is low, in this case, the borrower is at fault too for his negligence. The banks may not have provided proper communication and deliberately so. Still, it is difficult to absolve the borrower completely. Had the borrower looked at his home loan statement on a regular basis, he would have figured this out. Had he logged into his loan account, he would have noticed the applicable rate of interest and acted much earlier. He could have migrated to Base Rate or MCLR regime much earlier. Financial awareness helps.

Editor’s Note: Some banks deliberately make it harder for borrowers to get information on their home loan account online. While the information on SB, FD or investments accounts are available online or via mobile app, the borrower is generally directly to visit the nearest loan servicing branch to get revised loan amortization schedule, examine past EMI payments, prepay the home loan or switch to new interest rate regime. When compared to opening/closing an FD OR investing in mutual funds/equities online instantly, closing or prepaying a home loan is an intentionally laborious process. In such cases, borrowers have to be even more alert in tracking their loan interest rate changes.

Related Reading: Should You Switch from MCLR to EBR (or External Benchmark Loan)?

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