Recently i was going through the balance sheet of one of Home Loan Provider/Lender & was quite amazed to know that this particular lender’s Net Profit during last Financial Year was few thousand Crores & they have reserves of approx 4.5 times the annual net profit then Why Higher Interest Rate for Existing Home Loan Customers?
In April’12 when RBI cut Repo Rate by 50 basis point then ideally Home Loan Providers should have reduced their Base Rate or BPLR or RPLR to follow the movement of policy rates but it never happened. Though i have highlighted the issue of higher interest rate being charged from existing Home Loan Customers in my following post but many of my readers requested me to throw more light on this topic
In recent past, i received lot of queries from my readers who are paying very high interest compared to existing interest rates offered to new customers..They asked me why it is so…Let me clarify that its a vicious cycle, if person A has taken loan when interest rates were low then he will pay comparatively high interest rate then market rate when interest rates are high i.e. in current scenario.
Now you must be thinking that if person B has taken loan when interest rates are high then he will be paying comparatively lower interest rate then market rate when interest rate are low. But this situation never arises Let me explain this
Consider 2 Scenarios
(a) Low Interest Rate: Assume person A has taken loan in 2008 (when interest rates were low) from Lender X. The BPLR of Lender X was 12.5%. The Lender offered spread of 4% on BPLR & offered market interest rate of 8.5% to customer.
Now in year 2012, The BPLR of Lender is 16.5% and customer’s spread is 4% only therefore customer who took loan in 2008 is still paying interest rate of 12.5% whereas Market interest is 10.5%. For new customer interest rate will be 10.5% only becoz Lender will increase spread to 6%.
(b) Higher Interest Rate: Now assume person B has taken loan in 2012 (when interest rates are high) from same Lender X. The BPLR of Lender X is now 16.5%. The Lender is offering spread of 6% on BPLR to new customer & offered him market interest rate of 10.5% on Home Loan.
Now suppose in year 2015, market Interest rate is reduced to 8.5%. Here the Catch is, BPLR of Lender is decided at the sole discretion of Lender only and there is no scientific formulae to calculate the same. Even if interest rate go down, Lender will not reduce BPLR below 14.5% though market rate is now at same level of 2008 therefore going by law of justice the BPLR should also be at 2008 level but it will not happen becoz if Lender reduce BPLR to 12.5% then customer who took loan in 2012 will be paying interest rate of 6.5% i.e. 2% lower than Market Interest Rate.
In short Lender is OK if customer is paying higher rate than market rate but it is not comfortable at all with scenario where customer is paying slightly lower rate than existing market rate therefore he will tweak BPLR to its advantage and make huge profits.
Now for new customer, Lender will keep spread @ 6% therefore new customer will pay interest rate of 8.5% & both old customers i.e. Person A and Person B will also pay interest rate of 8.5% despite the fact that Person A paid very high interest rate in 2012.
In a nutshell, the people who will take Loan during Lower Interest Rate regime will always be at LOSS and people who will take Loan during High Interest Rate Regime will mostly pay Market Interest rate during Loan Tenure thus will be at advantage. In this case Person A is at heavy loss and Person B is paying almost market linked Interest rate.
Now another important question coming to ur mind is that how lender make profit. Let me tell you that Home Loan is most secured and profitable business in complete Financial Lending Portfolio. If i have to put in simple terms then i can say that Lender make profit by simply cheating the customer. None of the lender provide loan from its own pocket, they source fund from market by way of borrowing & then lend this money at slightly higher interest rate. Lending rate will always be slighter higher then Borrowing Rate.
Now u must be thinking, where is cheating in this case and if in 2008, Lender is borrowed at 7.5% and was lending at 8.5% then it deserves this margin of 1% to recover its cost and make slight profit. Let me explain how u r being cheated.
In 2008, lender borrowed at 7.5% and lend this money @ 8.5% as Home Loan. Now lender will pay only 7.5% interest rate on borrowed fund but in 2012 Lender is charging you interest rate of 12.5% on money which was borrowed at 7.5% i.e. Whooping Profit margin of 5%. Net profit of 5 Rs p.a. on every 100 Rs borrowed and lend it as Home Loan in 2008. Just keep in mind that own investment in terms of money circulation is Zero. Risk is very minimal becoz for Home Loan, the property in question is always mortgaged with Lender.
On lighter note , if someone is willing to lend me the money then i am also thinking of entering this highly profitable business.
Infact, no one is against company making profits becoz all organizations are operating to generate wealth for its shareholders but it should be through fair & transparent means not by sucking blood of customer…I really feel bad, when i come across these kind of cheating cases from my readers.
I hope better sense will prevail and Regulator will come out with some clear guidelines on how the Home Loan Portfolio should be managed by the Lenders so that instead of building huge reserves of 10,000-15,000 Crores they should also think of common man, who struggles through out his life for just 1 house.
Copyright © 2011-2012 Nitin Bhatia. All Rights Reserved.
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