How does bank determine PLR
Banks have to follow certain policies and rules set by RBI and maintain somethings like CRR, etc. I’m not gonna take you into the complexities of CRR, etc, but the important thing to note is that RBI rules are the once that force the banks to change their PLR.
The case of home loan (floating) is hurt by this PLR mechanism. Since bank has the sole decision making power, it can anytime increase (and seldom reduce) your floating home loan rates. If the RBI increases the rates for all the banks, the banks immediately change their PLRs and hence the floating rate repayment amount increases. But if the RBI reduces the rates, though it is a relief for the banks, the banks may NOT necessarily reduce the EMI amount for floating rate loan borrowers. The reason, banks reduce their PLRs after the rate cut by RBI, but increase the addition % factor that keeps the floating rate same for existing customers. Banks win on all the fronts – the individual looses out.
Though the market competition forces banks to keep rates competitive, but ultimately, the individual has to pay the price. The most recent example was observed during Dussehera- Diwali festival. Most of the banks reduced their home loans floating interest rates – many colleagues in my office were happy and waiting for a letter from the bank thinking that their floating rate EMI will reduce. But it did not happen. None of the loan repayers got respite or reduction in their EMI amounts. The reason – banks had lowered the interest rates only for NEW CUSTOMERS. For the existing customers, the rates remained the same.
Loan Borrower’s Dilemma
When the rates are high – the biggest dilemma is whether the rates will fall or rise. Durations like 20 years is a long time. Interest rates can vary anywhere from 2% to 25%. What can an individual do? Fixed or floating? And secondly, what exactly is high? Is it 10% or high means 15%? No one knows.
When the interest rates are low – That is the best time to take a FIXED home loan. The lowest rates in India have been in the range 6 to 7.5% in 2002 to 2004, yet individuals took floating rates home loan, believing that interest rates may fall further. Today, the same individuals are repaying double the initial EMI amount, as their effective floating rate has reached 12% or more.
Ultimately, it’s the uncertainty that you have to fight against. Remember, everything in the agreement is in favour of the bank. There is no such thing like if you take floating rate, then your EMI will go down if RBI reduces rates. It’s all a messed up business, and we individuals without any knowledge of finance become victims of it. There are no choices; people need a house to stay once they want to settle down. Just assess your cash inflows and certainty about them during the duration of loan and act accordingly.
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8 comments:
Welcome back, Shobhit. As ever, your article was interesting and enlightening. I especially like the way you are very clear about the basics and share that clarity with us all.
While on the topic of housing loans, what is your take on this current trend of everyone piling on the real estate craze? Although I can't put my fingers exactly on the nub (which is why I'm appealing to you here), I feel intuitively and very strongly that there is some kind of fallacy here, where everyone mortgages their next twenty years' earnings to buy houses they can't really afford.
I'm referring not to buying houses per se, but to people who can ill afford it and yet are buying expensive houses.
Your take on this?
Anonymous,
First thing - atleast leave your name when you are expecting a reply!
Coming to mortgages and loans, I've always stressed on the ignorance and faulty assumptions that ppl make while taking loans. Such assumptions should be avoided.
The markets are efficient - as long as there is demand, and we individuals (due to our ignorance and lack of financial planning) will keep on paying what the builders ask, the real estate prices will continue to rise. God knows till when.
People love to learn the hard and costly way - only after they suffer a setback. All I can wish is that individuals become knowledgeable about loans and money and act accordingly.
My apologies. The name's Roy. Siddhartha Roy. (Music in the background! And Halle Berry in a swimsuit!! -- Although Ursula Andress was the best, wasn't she?)
Hi Shobhit
Nice article, and i have lot many things to discuss here on Home loans, Investments & Returns.
Will you please throw some light on following?
The 20% part of home loan we contribute, what's the exact use of that? does that help us in Tax exemptions? does that generate any types of returns? or what do you say, how that 20% contribution help us financially? we know, we put our savings in that 20% right? so we even don't earn 6-7% that could have earned as FD in bank. Apart from pride, affection, feelings and honor (your own home, your contribution kinda) is there anything else would justify this 20%
Waiting for your kind reply.
Regards
Aniruddha
Hi Shobhit
Here is an interesting article related to our subject.... he defends why it's good not paying homeloans early, read complete article please
"Debt is good, especially when it's paid for by someone else, and when it's buying me an appreciable asset. Debt for stuff is bad. In fact, if you keep buying stuff all your life, you can easily guess what you end up with: STUFF.
A simple aside here: Land appreciates in value and buildings depreciate in value. Thus, invest in the dirt more than the building. That's why I don't like units, unless I own the whole block.
So, why is debt good? "
Read more here...
http://www.rediff.com/money/2007/nov/15book.htm
It's not always clear that fixed rates are better even when the interest rates are low - ask anyone who has had to take a loan.
For example, many banks keep the fixed rate about 0.5% above the floating rate. On a loan of 20 lacs, that's a difference of 10,000 in a year!
If you read the documents for a fixed-rate loan, you'd see that the term "fixed" is a gross misnomer since the bank can change it anyway if it determines (at its sole discretion) that the rate is not viable for it any more.
Of course, as you have pointed out, the term "floating" is also dishonest - the banks are quick to raise the rates when necessary but forget to do so when they can be lowered.
The borrowers are damned either ways.
Hi Shobit,
I too have read that fixed is not actually fixed.The bank can increase a fixed home loan if they feel that the fixed rate is no longer feasible.Infact the documents which we sign for home loan also has this clause where in the bank can increase the fixed home loan rate any time it feels it is no longer feasible.So is fixed home loan then better than floating rate loan?
If you observe keenly there is no such thing as true fixed loan. The Bank can revise the fixed loan interest every three years and bring it close to the prevailing market rate. When the rate goes up, banks increase the loan when it decreases the leave it unchanged
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