Consumers would not like to change their current situation even when it is clearly beneficial for them and when it costs them nothing to make the change. It requires a big nudge for them to do what is obvious to you and me. I have seen this principle in action in the case of home loans. Ask any home loan borrower and you will find he is aware of his original home loan amount and his monthly equated monthly instalment (EMI). He has a hazy idea about the interest rate - mostly the original interest rate that he had agreed when he had taken the loan. He will be equally hazy about the current loan dues. In short, the only thing stuck in his head is the monthly EMI. And, since it is payable over a very long time, he has even less idea about the balance instalments he is required to pay. Meanwhile, the bank could have increased the interest rates quite significantly but it just registers as a vague notion in his mind, if at all.
Reason: His EMI does not change and only the balance loan tenure is increased by the bank. Since the earlier tenure itself did not register in his mind, the increased tenure has no chance of registering at all. He knows his existing lender is overcharging him but inertia makes sure he does not take any action for changing it. Once in a while, in a fit of action, after reading articles such as this one, he will go online and use loan aggregation websites to get competitive offers from other lenders.
The surprising thing is that even after getting such offers, quite a few of them don't make the switch and lapse back into the inertia of repaying the same EMI. This fact was brought home to me when my own senior colleague just neglected taking any action on shifting his home loan even though he was paying an interest rate of 11.50 per cent. This when he had got offers for as low as 10.25 per cent (benefit of 1.25 per cent a year on a home loan of Rs 45 lakh). The sales person of the new lender had explained to him that the balance period of his loan would go down from 208 months to 172 months, that is, by three years. Since he was paying an EMI of Rs 50,000, his total savings would be Rs 18 lakh. The salesperson promised service at his doorstep and yet even this kind of a saving had not impelled my colleague to make the small effort to provide and sign various documents and letters required to switch lenders. A little probing solved this apparent puzzle.
I then spoke to a smart distributor who offered two choices to my colleague. They were:
n Reduce the EMI to Rs 46,300 from Rs 50,000 a month and balance period remains 208 months
n Take an extra loan of Rs 3.50 lakh and the EMI still remains at Rs 50,000 a month and the balance tenure remains 208 months
My colleague jumped at the second offer as it was an answer to a prayer. He had wanted to renovate his house and the extra cost-free loan of Rs 3.50 lakh was just the incentive he needed to overcome his inertia and make the required small effort to switch his loan.
This whole episode left me wondering why all the other banks who had made the loan switch offers to him had not positioned it the same way. One reason of course was the entrepreneurial energy brought in by the distributor for completing a transaction. But I think a much better explanation for this is that he intuitively understood that a cost-free loan offer will make the consumer overcome his inertia. He also knew from experience that my colleague's existing bank was most unlikely to match the offer in this manner.
The only reason banks don't offer this option first when they drop rates is because credit risk increases if a loan is given without monitoring its usage. The increase in credit risk is very mild if the consumer has a proven track record for the same EMI amount for a long period. Thus, they offer it if the consumer demands it but not on their own.
Even as public sector banks are currently wooing existing home loan borrowers by offering them lower EMIs, a set of bankers and their street-smart distributors have started offering the additional loan. Any guesses on which is likely to attract more consumers?
The writer is CEO, Apnapaisa.com
Reason: His EMI does not change and only the balance loan tenure is increased by the bank. Since the earlier tenure itself did not register in his mind, the increased tenure has no chance of registering at all. He knows his existing lender is overcharging him but inertia makes sure he does not take any action for changing it. Once in a while, in a fit of action, after reading articles such as this one, he will go online and use loan aggregation websites to get competitive offers from other lenders.
The surprising thing is that even after getting such offers, quite a few of them don't make the switch and lapse back into the inertia of repaying the same EMI. This fact was brought home to me when my own senior colleague just neglected taking any action on shifting his home loan even though he was paying an interest rate of 11.50 per cent. This when he had got offers for as low as 10.25 per cent (benefit of 1.25 per cent a year on a home loan of Rs 45 lakh). The sales person of the new lender had explained to him that the balance period of his loan would go down from 208 months to 172 months, that is, by three years. Since he was paying an EMI of Rs 50,000, his total savings would be Rs 18 lakh. The salesperson promised service at his doorstep and yet even this kind of a saving had not impelled my colleague to make the small effort to provide and sign various documents and letters required to switch lenders. A little probing solved this apparent puzzle.
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The saving of Rs 18 lakh was just not hitting his mind as it made no immediate difference in his life, since his EMI remained the same at Rs 50,000 and the savings was a long way off in the future (after 14 years).
I then spoke to a smart distributor who offered two choices to my colleague. They were:
n Reduce the EMI to Rs 46,300 from Rs 50,000 a month and balance period remains 208 months
n Take an extra loan of Rs 3.50 lakh and the EMI still remains at Rs 50,000 a month and the balance tenure remains 208 months
My colleague jumped at the second offer as it was an answer to a prayer. He had wanted to renovate his house and the extra cost-free loan of Rs 3.50 lakh was just the incentive he needed to overcome his inertia and make the required small effort to switch his loan.
This whole episode left me wondering why all the other banks who had made the loan switch offers to him had not positioned it the same way. One reason of course was the entrepreneurial energy brought in by the distributor for completing a transaction. But I think a much better explanation for this is that he intuitively understood that a cost-free loan offer will make the consumer overcome his inertia. He also knew from experience that my colleague's existing bank was most unlikely to match the offer in this manner.
The only reason banks don't offer this option first when they drop rates is because credit risk increases if a loan is given without monitoring its usage. The increase in credit risk is very mild if the consumer has a proven track record for the same EMI amount for a long period. Thus, they offer it if the consumer demands it but not on their own.
Even as public sector banks are currently wooing existing home loan borrowers by offering them lower EMIs, a set of bankers and their street-smart distributors have started offering the additional loan. Any guesses on which is likely to attract more consumers?
The writer is CEO, Apnapaisa.com