In a major relief to home buyers, RBI has asked banks not to impose prepayment penalties on floating interest home loans irrespective of the source of funds. RBI has rightly pointed out that floating rate loans pass on the interest rate risk from the banks to borrowers. Thus, banks only substitute interest rate risk with potential credit risk. RBI has also directed banks to revive long-term fixed rate housing loans to their customers and address their market liability mismatch by recourse to the Interest Rate Swaps (IRS) market and not just rely on short-term deposits. Banks can continue to charge reasonable prepayment penalties for fixed-rate loans. These decisions were taken at the annual conference of banking ombudsmen held at RBI headquarters in Mumbai on September 5, which was inaugurated by RBI governor D Subbarao. Though the suggestion of the banking ombudsmen are suggestive in nature, it is generally accepted by the banks.
Current lending situation
Currently, some banks do not penalise if the borrower pays from their own funds and does not borrow from another bank (at a competitive rate) to prepay the existing loan. Some banks do not levy pre-closure charges on the borrower during the first 2-3 years of loan tenure if the prepayment amount is up to 25% of the principal outstanding. Prepayment charges generally range from 1-3% with some charging as high as 5% if the borrower refinances the loan.
Long term fixed interest home loans have become a thing of past. Banks either price them higher or incorporate ‘reset’ clauses that protect their own interests. Some banks have begun offering dual rate (fixed-cum-floating rate) loans, but the timing is not in favour of the borrowers.
How do the proposed changes benefit the borrowers?
Considering that 80% of the home loans in India are floating rate loans, this is bound to cheer up borrowers. While banks are quick to raise EMI amounts with increasing interest rates, many a times they do not pass on the benefits of falling rates immediately to existing customers. In such cases, borrowers can refinance their loan with another bank to take advantage of declining interest rates. As we pointed out earlier, floating rate loans tend to be cheaper when compared to fixed rate loans in the long term. Combined with ‘no prepayment’ charges and a tax incentive on interest paid up to R 1.5 lakhs every year on housing loan, this is probably the best option for borrowers in times of high interest rates.
Also, long-term fixed rate and dual rate home loans form about 20% of the home loans in India. If banks were to provide long-term fixed rate home loans when the interest rates decline, this would allow borrowers to budget their monthly expenses and provide security of fixed EMI payments for the entire loan tenure.