Home loan portfolio has the lowest delinquencies and this can be a win-win situation for both the lender and borrower if it can be achieved by innovative strategies but in a transparent way
President Pranab Mukherjee, in his address to the Joint Session of Parliament on 9 June 2014 had announced, “by the time the Nation completes 75 years of its Independence, every family will have a pucca house with water connection, toilet facilities, 24x7 electricity supply and access.”
As a follow up of this commitment, the Central Government recently announced the National Mission for Urban Housing called ‘Housing for All by 2022’ which is a bold attempt not only to galvanise the housing market but also to improve the life of people living in urban areas of the country. In the wake of this, the Ministry of Housing and Urban Poverty Alleviation has published the guidelines, which elaborately propose a series of measures for implementation over the next seven years. This includes credit-linked subsidy scheme to the eligible urban poor, comprising of economically weaker section (EWS) and low income group (LIG) to be routed through banks and housing finance companies in the country.
This whole exercise entails enormous amount of funding of homebuyers through home loans by banks and housing finance companies (HFCs) that have an onerous responsibility to ensure that home loans are tweaked according to needs of the borrowers and make them attractive enough to borrow from banks. Unfortunately there is very little innovation in home loans at present, though couple of years back, a few banks had introduced what were called as teaser home loans, which did not last long.
What are teaser loans?
It was all started in 2009-10 when banks found that the best way to expand credit was to attract people to avail home loans as they found that this was the safest way to increase their retail loan portfolio, since the delinquency was lowest in housing loans. A few banks, led by State Bank of India (SBI) offered home loans to new borrowers at a much lower rate of interest on fixed interest rate basis for first two years, where after the loan would be converted into floating rate at the then existing higher interest rate.
These home loans not only attracted a lot of interest amongst home buyers, but it also generated criticism from competitors who considered it as a ploy to attract innocent home buyers who were not informed of the consequences of interest rate movements. HFCs came out strongly against these schemes by describing them as a gimmick and identified them as teaser loans.
The Reserve Bank of India (RBI), then felt that such teaser loans were riskier and the probability of default was higher due to the ignorance of borrowers of the implications of higher interest rates charged after the initial period of say two or three years. RBI, therefore, imposed an additional provisioning requirement of 2% over and above the normal provisioning on such loans, which made those loans unattractive for the banks who withdrew the schemes in 2011.
If not teaser loans, home loans definitely need innovation!
RBI’s views at that time were guided by the sub-prime crisis that led to the collapse of Lehman Brothers of US and the global meltdown that followed. That made RBI a bit cautious and did not view this innovation favourably.
Today, there is a need to encourage retail lending as banks are cautious to lend to large projects due to the mounting non-performing assets (NPAs) in their balance sheet, which is causing pressure on their profitability. And that is why SBI has again sought the views of the RBI on this issue, and hopefully, the central bank might allow banks to reintroduce this innovative scheme with appropriate checks to safeguard the interest of the borrowers, as there is always scope for new ideas even in a mundane banking business.
Whether the teaser loans are re-introduced or not, there is certainly a need to encourage banks to come out with innovations in home loans in the context of Government of India launching a very ambitious programme of “Housing for All by 2022”. As per the present estimate, India will need an additional 11 crore housing units by 2022, which means a huge responsibility is cast on banks and HFCs to finance these large number of houses during the next seven years.
What are the innovations feasible and desirable?
1. Credit score to decide the interest rate on the loan:
Banks today first ascertain from the credit information bureaus, the credit history and score of the potential borrower to assess risk/s involved in lending. If they find that the credit history and score are up to the mark, the application for a loan is considered favourably because it indicates promptness in meeting commitments, which is considered as a good risk for lending. While banks vie with each other in attracting such high quality borrowers, they hardly give the benefit of lower rates of interest to such borrowers, and treat them at par with other borrowers so far as interest rate is concerned. There is a need to introduce variation in interest rates depending on the credit history/score of the applicant to encourage credit discipline in borrowers, as it will ultimately benefit the lending institution, which stands to gain by prompt repayment of their loans. Banks should, therefore, follow the principle of good credit history and higher the credit score, lower the interest rate, which is not uniformly applied today.
2. Link the interest rate to Loan to Value Ratio (LTV)
RBI has stipulated certain margin to be retained by the bank while lending on the security of the house to be mortgaged for the housing loan. This is called the Loan to Value ratio (LTV). The following is the present guideline in force:
For example, if a homebuyer mortgages a property worth Rs30 lakh, he can get a maximum loan of Rs24 lakhs retaining a margin of 20% on the loan. But if he seeks a loan of only Rs20 lakh after investing his own savings of Rs10 lakh, which is his equity, the margin on the loan come to 33.33%, which is much higher than the 20% stipulated as per the rules. This provides an additional margin of safety to the bank and, therefore, there is a need to offer lower rate of interest to the borrower to compensate for the higher margin of safety provided by him by investing his own money. Lower the Loan to Value Ratio, lower the interest rate should be the guiding principle for all home loans.
3. Reward borrower for early payment of EMIs
The banks have a policy of levying a penalty if equated monthly instalments (EMIs) are paid with delay even of a few days. But at the same time, banks do not reward the customers if EMIs are paid in advance of their due dates. Most of the banks do not even give the benefit of early payment of instalments by appropriate credit in calculation of interest on daily product basis like in savings account. If banks are generous enough to reward borrowers who pay in advance of the due dates, it will encourage them to pay the instalments in advance, which is beneficial to banks in the long run.
4. Home loans in the form of Overdrafts
A few foreign banks do grant home loans in the form of overdraft accounts, which is a variation from the term loan system followed by most of the banks today. This system of granting loans through overdrafts gives considerable advantage to the borrower as interest is calculated on the net debit balance in the account on daily basis like in savings bank accounts. Besides, for the salaried class it helps in getting the benefit of interest at the home loan rate on surplus funds held in the account during the earlier part of the month, which otherwise would have remained in the savings bank account with a paltry interest of 4% per annum. Over the period of the entire loan, this savings in interest becomes substantial if the interest rate on the overdraft is comparable with the rate offered by banks in the traditional loan account. If the borrower is able to follow the rules of overdraft system, this is the better way to borrow even for long term, if the rate is competitive. Public sector banks (PSBs) too should give the benefit of loans in the form of overdraft to those who wish to borrow under this novel method and thus widen the choice for the homebuyers.
5. Mortgage Guaranteed Housing Loans
Last week a new concept of mortgage guaranteed home loans has been introduced in association with the Indian Mortgage Guarantee Corp set up jointly with the National Housing Bank (NSB), Genworth Financial, International Finance Corp (IFC) and the Asian Development Bank (ADB). Mortgage Guarantee is a product which compensates lending institutions or housing finance companies for losses that may arise when a home owner defaults on a mortgage loan. This is a new concept just introduced in India and requires to be fine tuned to make them attractive enough to meet the needs of the discerning Indian home buyers.
Banks can help to achieve the dream of every Indian household to own a home:
Owning a home is the dream of every Indian family in our country irrespective of the economic conditions in which they live. With the thrust given by the Indian Government to ensure that every family will have a roof over its head by the 75th anniversary of country’s independence, here is an opportunity as well as a challenge for the banks and housing finance institutions to play their part well to achieve the objectives set before them. As is well known, home loan portfolio has the lowest delinquencies; this can be a win-win situation for both the parties to the loan if it can be achieved by innovative strategies but in a comprehensible and transparent way.
(The author is a financial analyst, writing for Moneylife under the pen-name ‘Gurpur’.)