According to the revised model for education loan, the repayment period is now extended up to 15 years depending on the loan amount
Indian Banks' Association (IBA) in its revised circular for education loan has recommended extension for the repayment period depending on the loan amount as well as asked banks to clear a loan application file within a month.
Prabhuta Vyas, senior vice-president, social banking, IBA told Moneylife, "The circular for the revised model on education loan was sent to member banks on 30th August with immediate effect.
Earlier, students had to start repaying one year after completing the course or six months after getting a job, whichever was earlier. The loan repayment tenure was between five to seven years. This has been extended to 10 years for loans up to Rs7.5 lakh and 15 years for loans above Rs7.5 lakh.
IBA had also recommended of creating a credit guarantee fund to tackle the problem of rising defaults in the loan category up to Rs4 lakh. "The recommendation (credit guarantee fund) is still pending with the government."
Prashant Bhonsle, country head of Credila Financial Services, which specialises in education loan says, "From the point of students and parents, the extended repayment is good news. As the EMIs amount decreases, the default risk also gets lower. This would also help to mitigate risk to a certain extend. However, this would be challenging for banks to track student borrowers for 15 years. At Credila, we provided tenure of repayment up to ten years, after understanding the need of the students. We felt that a student should not have any debt obligation during the initial years of his career."
Experts point out that there was no need to extend the repayment period as the student and their parents would have continued to apply for the loan and pay back on time. The higher extension of repayment period may lead to lesser lending by the banks. However, banks have welcomed the revised model of education loan.
An official with leading public sector bank, preferring anonymity, told Moneylife, "Our bank will redraft the scheme according to the revised model and put it before the board for approval. Up to ten years of repayment period is good considering five years of studies and two years of employment. Even housing loan has such repayment period. There is some risk, but the education loan scheme is becoming popular among the students and there is clear demand. Overall this revised model is pretty workable."
B Vara Prasad, general manager (retail, payments and settlements and third party products), Union Bank of India, says, "There is nothing wrong in the revised model. It would put less pressure on the students to repay his loan. We welcome such move."
The revised scheme proposed by IBA has addressed concerns and operational difficulties faced by the lenders. According to the revised model, merit would be the sole criteria to be eligibility for the approval of education loan, admission under management quota would be kept out of the scheme, loan quantum would be justified by the employment benefit and extension of the repayment period to reduce the burden on the beneficiaries.
According the revised model there will be no penalty on prepayment. There would be no processing charges levied on loans sanctioned. If banks charges, processing fee for student going abroad for studies, it would be refunded upon the student taking up the course.
IBA said, "Bank may provide 1% interest concession if interest is services during the study period and subsequent moratorium period prior to commencement of repayment."
It also said that meritorious students from the same family are eligible for the loan. "Existence of an earlier education loan to the brother(s) and or sister(s) will not affect the eligibility of another meritorious student from the same family obtaining education loan as per this scheme from the bank," the IBA said.
According to the current guidelines, banks lend up to Rs4 lakh without any security. But for loans between Rs4 lakh and Rs7.5 lakh, they can ask for personal guarantees, and for a loan above Rs7.5 lakh collateral is required.
Indiabulls Housing Finance head explains that increasing the EMI is better than extending the loan tenor
The corporate sector had hoped otherwise, but the Reserve Bank of India (RBI) today hiked key interest rates by a further 25 basis points. This will likely make home and automobile loans still more expensive and realtors believe that property prices will go up further. In this situation, Sachin Chaudhary, business head of Indiabulls Housing Finance, has advised borrowers not to go for fixed-rate loans or to extend loan tenors.
"In a high rate scenario, try and increase your EMI if your pocket allows. Do not go for fixed rate loans, because the rates are expected to soften," Mr Chaudhary said. He also argued that it was preferable to keep the tenor constant than to pay a fixed amount of EMI. In the latter case, the interest increases significantly by the time the loan is repaid. "Don't increase the loan tenor," he said.
The Indiabulls Housing Finance head also explained that in the case of a fixed tenor the effective rate is much lower, because deductions on home loans result in tax benefits. He demonstrated this through an example: When the tenor is fixed for 180 months, and if rates are hiked by 0.25% with each successive EMI payment, even though the EMI amount on every Rs1 lakh increases, the overall increase in rate of interest after six successive hikes is 9%. However, when the EMI is fixed and the tenor keeps on increasing by even one month, after six extensions, the interest rate is increased by 22%.
Mr Chaudhary advised that in the present situation, it was better to renegotiate the rate of interest rather than switch to another financial institution. He also said that prepayment was the best option, and a part prepayment could reduce the loan tenor up to 50%.
Most banks offer loans that have tenets of 'teaser loans', that is a fixed rate for the first few years and then at par with floating rate loans. Experts think that the interest rate hikes are nearing their peak, and a lock in for 3-5 years is not advisable. "In most cases, the fixed-floating hybrid loans favour the lender and not the buyer," said an analyst.
The RBI today announced a hike in interest rates, the 12th time it has increased rates since March 2010. Repo rate now stands at 8.25% and the reverse repo rate at 7.25%.
Indian Overseas Bank chairman and managing director M Narendra said, "I believe banks will wait till the month-end before taking a call on an interest rate hike." Bankers are of the opinion that the rate increase will be passed on to customers sooner than later.
The series of rate hikes has resulted in the EMI on home loans going up by more than 20% to Rs1,016 on every one lakh rupees. However, with rates having climbed so high, it would not be wrong to assume that any further increases should be very limited
The past 12 months have seen interest rates on home loans rise from 8% to 10.75%. This has resulted in equated monthly installments (EMI) going up by 21% from Rs837 for every one lakh rupees on the loan to Rs1,016. The question facing home buyers today is whether to go ahead and buy a house if and when real estate prices do decline, or wait till interest rates drop too. Before we answer that, let us understand why interest rates increase or decrease and what the long-term implications are for home buyers.
Interest rates in India are largely a function of the monetary policy, which is decided by the Reserve Bank of India (RBI). The RBI has several goals; the most difficult of them is to maintain a balance between the need to ensure economic growth and control inflation. When inflation rises and threatens to spin out of control, as it has today, the RBI 'tightens' monetary policy. This amounts to reducing, or making expensive, the money supply in the economy.
The RBI achieves this by either increasing the repo rate (the rate at which banks borrow from the RBI) which increases borrowing costs, or increasing the cash reserve ratio (CRR) which has the effect of reducing money supply in the economy. Though the RBI's policies could take up to a year to have their full intended impact, they are perhaps the most effective way to reduce inflation.
The RBI has increased repo rates nine times in the past 12 months, from 5.25% to 8%, towards curbing stubborn inflation. This has resulted in an increase in the base rates of banks and the prime lending rates (PLR) of housing finance companies by 2.5%-3%. Consequently, home loan rates have increased from around 8% per annum to 10.75% and the EMI has shot up by 21%.
This increase in EMI impacts buyers' budgets and often persuades them to wait for the interest rates to come down. As almost all home loans are offered on a floating rate basis, the interest rates applicable would increase in line with rising interest rates. This would mean that even if you had taken a loan at 8%, the current rate would be 10.75%, and either the EMI would have gone up or the tenor (repayment period) of the loan would have increased. Clearly, home-buying decisions should not be influenced by the level of interest rates prevailing at the time of the purchase of house.
However, there are long-term implications for home buyers who take a mortgage, since interest rates are cyclical in nature (illustrated below by repo rate movement over the past six years).
Interestingly, when interest rates are high, there is a smaller probability of a further increase in the interest rate, and thereby a lesser risk of the burden of an increase in EMI. Conversely, in a low interest rate environment, the risk of a subsequent increase in interest rates, leading to a bigger EMI burden is higher.
The correct strategy, especially in a low interest rate environment, would be to assume that interest rates can go up by as much as 2%. Interest rates have averaged 10% over the past 10 years for home loans and hence the assumption of a 10% interest rate is a good thumb rule to calculate your repayment capacity.
The tax benefit available on housing loans is an important consideration since it reduces the effective cost of borrowing. As illustrated (below), the effective cost of borrowing is still below 8% for an average home buyer.
In conclusion, current high interest rates should not deter one from buying a house, but it would be wise to keep some cushion in one's borrowing capacity, to provide for increases in interest rates and the consequent increase in EMI.
(Gagan Banga is a writer and CEO of Indiabulls.)