 "Take a home loan from an NBFC only if banks refuse")
National Housing Bank (NHB) that regulates all housing finance companies (HFCs) such as HDFC, LIC Housing Finance, etc, is reportedly considering allowing them to collect prepayment charges if a floating rate home loan is prepaid within the first few years.
There are valid arguments for this, including the high upfront costs that lenders incur while giving the loan, which can only be recovered over the longer tenure of the loan. Hence, early prepayment leads to a loss for the lenders. Under normal circumstances, the lenders should be charging an upfront fee to cover these costs, but competition ensures that at least in this area they are unable to do so.
Hence, the proposal to partially do away with the regulation that stipulates nil prepayment charges. However, rather than directly issuing instructions in this regard, it has reportedly approached the Reserve Bank of India (RBI) to allow banks to have the same facility.
It is very instructive to understand this rather strange reluctance to issue instructions to the entities it regulates and instead approach another regulator to provide a similar concession to banks as well. To understand this, let us refer back to why prepayment charges were banned by both NHB and RBI in the first place.
The entire home loan sector discriminates by charging higher rates to existing consumers whilst giving lower rates to new consumers. When the complaints on this score became embarrassingly high, the regulators refused to ban this discrimination but banned pre-payment charges instead. This allowed at least the more active and conscious home loan consumers to switch their loans at no extra cost.
The practice of charging higher rates to existing consumers continues to this day because the lenders know that only a miniscule minority of the loan consumers are active enough to actually shift their loans. This minority is, however, growing significantly, aided by the rise of social media. It is hurting bottom lines, as the discrimination can no longer be as high as it used to be earlier.
Data proves that discrimination between new and old consumers has reduced after prepayment charges were banned. This is the background to the NHB proposal, reportedly addressed to RBI, as it knows HFCs by themselves cannot implement this practice that will institutionalise discrimination, unless banks are allowed the same freedom.
NHB's interests are more closely aligned to the bottom lines of HFCs since it is a significant lender to them rather than protection of consumer interests. In a burst of activism in October 2011, it had issued a regulation banning the practice of discriminating between existing and new consumers.
Under pressure from the sector, it did not check on implementation of the said regulation and then quietly withdrew the said regulation in 2014. No reasons were given in the circular withdrawing the regulation. No alternative measures have been put in place for protection of HFC consumers. That speaks volumes about the consumer concerns NHB has shown.
In any case, HFCs have a structural advantage to discriminate against existing home loan consumers. They do not have the equivalent of the "base rate" that banks have and charge a discount from their prime lending rates (PLRs). When they need to drop the rates for new consumers they increase the discount from the PLRs and existing consumers continue paying the higher rate. Banks cannot do this, as they cannot lend below their base rates. The SBI chairperson was referring to this "regulatory arbitrage" that allows HFCs to discriminate against existing borrowers.
Now, almost like an industry body of lenders, NHB has requested RBI to allow banks prepayment charges. RBI has reportedly sought the views of banks, which expectedly are all in favour of this proposition. RBI appears to be on course to make the loan rate fixation process transparent, with a stated commitment to move to the process of linking base rates to the marginal cost of funding in the first instance and then linking floating rates to external benchmarks.
So, if the base rate does get linked to an external benchmark, there cannot be any possible objections to the reinstatement of prepayment charges, not only during the first few years but during the entire duration of the loan.
Hopefully, RBI will resist pressures to allow prepayment charges till it puts the external benchmarking process in place. While all this action is taking place, new home loan consumers should seriously think whether it makes sense for them to borrow from a housing finance company at all, if they have a choice available between a bank and a HFC at the same rate.
There are valid arguments for this, including the high upfront costs that lenders incur while giving the loan, which can only be recovered over the longer tenure of the loan. Hence, early prepayment leads to a loss for the lenders. Under normal circumstances, the lenders should be charging an upfront fee to cover these costs, but competition ensures that at least in this area they are unable to do so.
Hence, the proposal to partially do away with the regulation that stipulates nil prepayment charges. However, rather than directly issuing instructions in this regard, it has reportedly approached the Reserve Bank of India (RBI) to allow banks to have the same facility.
It is very instructive to understand this rather strange reluctance to issue instructions to the entities it regulates and instead approach another regulator to provide a similar concession to banks as well. To understand this, let us refer back to why prepayment charges were banned by both NHB and RBI in the first place.
The entire home loan sector discriminates by charging higher rates to existing consumers whilst giving lower rates to new consumers. When the complaints on this score became embarrassingly high, the regulators refused to ban this discrimination but banned pre-payment charges instead. This allowed at least the more active and conscious home loan consumers to switch their loans at no extra cost.
The practice of charging higher rates to existing consumers continues to this day because the lenders know that only a miniscule minority of the loan consumers are active enough to actually shift their loans. This minority is, however, growing significantly, aided by the rise of social media. It is hurting bottom lines, as the discrimination can no longer be as high as it used to be earlier.
Data proves that discrimination between new and old consumers has reduced after prepayment charges were banned. This is the background to the NHB proposal, reportedly addressed to RBI, as it knows HFCs by themselves cannot implement this practice that will institutionalise discrimination, unless banks are allowed the same freedom.
NHB's interests are more closely aligned to the bottom lines of HFCs since it is a significant lender to them rather than protection of consumer interests. In a burst of activism in October 2011, it had issued a regulation banning the practice of discriminating between existing and new consumers.
Under pressure from the sector, it did not check on implementation of the said regulation and then quietly withdrew the said regulation in 2014. No reasons were given in the circular withdrawing the regulation. No alternative measures have been put in place for protection of HFC consumers. That speaks volumes about the consumer concerns NHB has shown.
In any case, HFCs have a structural advantage to discriminate against existing home loan consumers. They do not have the equivalent of the "base rate" that banks have and charge a discount from their prime lending rates (PLRs). When they need to drop the rates for new consumers they increase the discount from the PLRs and existing consumers continue paying the higher rate. Banks cannot do this, as they cannot lend below their base rates. The SBI chairperson was referring to this "regulatory arbitrage" that allows HFCs to discriminate against existing borrowers.
Now, almost like an industry body of lenders, NHB has requested RBI to allow banks prepayment charges. RBI has reportedly sought the views of banks, which expectedly are all in favour of this proposition. RBI appears to be on course to make the loan rate fixation process transparent, with a stated commitment to move to the process of linking base rates to the marginal cost of funding in the first instance and then linking floating rates to external benchmarks.
So, if the base rate does get linked to an external benchmark, there cannot be any possible objections to the reinstatement of prepayment charges, not only during the first few years but during the entire duration of the loan.
Hopefully, RBI will resist pressures to allow prepayment charges till it puts the external benchmarking process in place. While all this action is taking place, new home loan consumers should seriously think whether it makes sense for them to borrow from a housing finance company at all, if they have a choice available between a bank and a HFC at the same rate.
The writer is a registered investment advisor