Market yet to respond to rate cuts on home loans, share prices unaffected

Lower rates to aid loan demand for financiers who can offset discounts over the long tenure

The housing finance majors are trying to create demand during the festive period by cutting interest rates. Mortgage major HDFC has cut its minimum mortgage rate to 6.7 per cent. The NBFC is responding after cuts from State Bank of India (SBI), Bank of Baroda, Kotak Mahindra Bank, and Punjab National Bank (PNB). Most are offering rates between 6.5 per cent and 6.9 per cent.

Every lender is looking at the mortgage market as a relatively safe stream. Mortgage defaults are rare and, at least in theory, a recoverable asset exists in case of a default. Given corporate NPAs are fairly high, housing loans are therefore a target.

Second, interest rates are low and not likely to rise, so long as the RBI maintains liberal monetary policies. The central bank is committed to economic recovery and it has held policy rates down, despite a spurt in inflation. The real interest rate on treasuries is near-zero. The economic recovery will pull India back to 2019-20 (pre-pandemic) levels of GDP only in 2022-23. Hence, policy rates may stay low for an extended period.

This is a discount of between 30-45 basis points for most lenders. HDFC has maintained a loan spread of 2.3 per cent on its portfolio for several years. Individual loans (the majority of this is mortgage finance) have a spread of 1.93 per cent in the April-June 2021 quarter. The overall cost of borrowings for HDFC in Q1, 2021-22 was 5.9 per cent while its blended return was around 8.2 per cent. The cost of finance was 6.7 per cent in FY 2020-21 –it has dropped substantially. The NBFC may expect the cost of finance to fall further. The banks have lower costs of financing. Similar logic holds.

From the lenders’ perspective, this makes sense. HDFC is offering this rate for a limited period, but if other lenders stick with low rates, it may extend the discount. If prospective house owners take these loans, we’re talking about an average payback period of 11 years. Since mortgages are generally variable interest, the lenders can reasonably expect to even up the spreads over the long tenure of the mortgage.

From the home owners’ perspective, key factors are affordability and the EMI, rather than calculations of small interest rate differentials, which may compound out to significant sums over 11 years, or more.

One point HDFC and other lenders have made is that housing affordability has improved, calculated on the basis of the average annual income of home-owners versus average cost of property mortgaged. This is true since real estate prices have stagnated or fallen. But it could, in part, be deceptive since only people who can afford to take out a mortgage and service it, apply for loans.

That’s a small percentage of the population, if we look at a second statistic. India has low mortgage penetration of just 11 per cent of GDP. It is around 20 per cent for China and over 50 per cent for the US. So there’s an upside, but also an implication that most Indians cannot afford to buy real estate.

There have been worries about “K-Shaped” economic recovery with high-income earners doing much better than mid/low income earners. This could mean greater mortgage demand at the higher end of the market, where sensitivity to rate cuts is lower. The stock market hasn’t really responded one way or another to the rate cuts with share prices more or less unaffected.