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Housing Loans

Housing Loans

Why do banks charge existing customers more than their rate for new customers? Is it a way to ‘fleece’ customers who they think are stuck with them?

Loans by banks are linked to their base rates (below which they cannot lend). The loan rate is usually base rate plus a margin, for example, base rate plus 50 basis points or bps.

Banks arrive at the base rate after looking at their cost of funds and other factors. That is why it is different for each bank.

“As banks review their base rates at least once a quarter, floating rates may go up (or down) based on the call taken by each bank,” says Brijesh Parnami, CEO, distribution, Destimoney Enterprises, which provides mortgage-related advice to retail customers.

The base rate may change but the bank cannot alter the spread or the margin at which it has offered loans to existing customers. So, if the base rate comes down from 10% to 9.75%, the interest rate for existing customers will fall from 10.5% to 10.25% (considering a spread of 50 bps).

However, banks can offer new loans at a higher or lower margin, say, base rate plus 25 bps. So, for a new customer, the rate will be 10% (base rate at 9.75%), while old customers will continue to pay 10.25%. Existing borrowers feel ‘cheated’ by such a difference in rates.

“It (differential rates) may happen with a few lenders, but is not a general practice. Actually, it depends upon the pricing methodology followed by individual lenders,” says V.K Sharma, managing director and CEO, LIC Housing Finance.

The difference in rates were higher when banks used to benchmark home loan rates to Prime Lending Rates or PLR.

“Ever since banks have shifted to base rates, the difference has come down sharply than what it used to be when home loan rates were benchmarked to banks’ PLRs,” says Vishal Dhawan, founder and chief financial planner, Planahead Wealth Advisors.

PLR is the rate banks used to offer to their most creditworthy customers. However, the system was imperfect, with banks subsiding corporate customers by charging more from retail borrowers. That is why the RBI introduced the base rate system in July 2010.

There are two ways to deal with the problem of differential rates. One, you can switch the loan to a bank offering a lower rate. This is easy now as pre-payment penalty on floating rate loans has been abolished. The new bank will charge only a processing fee of 0.5-1% of the outstanding loan. Some banks may even waive the fee if you bargain hard.

Another option is switching to the lower rate being offered to new customers by paying a small fee. Most banks offer this facility to retain customers.

“Banks do not publicise this facility and offer it to customers only on demand or when they show willingness to shift to another bank. That is why many customers are not aware about this,” says Bakshi of BankBazaar.com. Not all lenders allow switching to a lower rate. Some instead reduce the tenure of the loan.

Housing Loans

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