Old Customers pay more for their Home Loans than New Customers
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Source : Economic Times
Rising interest rates on home loans is bad news for any borrower, but it is particularly bad for those who got loans at floating rates in late 2004 or early 2005. Such borrowers are effectively paying between 0.5 and 2.0 percentage points higher than new borrowers.
Why is that the case? Read on. Both the main lenders in the home loan segment, ICICI Bank and HDFC Ltd, which control almost 50 percent of the market, have increased rates for existing borrowers around half a dozen times since November 2004. Every time their benchmark lending rate goes up, the increase is passed on to old customers. To lure new customers, however, they are willing to settle for a lower increase in the rate for fresh borrowers, by increasing the discount to the benchmark rate.
As one banker says, “an old customer is like your wife, a new one is like your girlfriend.”
A large number of borrowers borrowed at 7.50 percent in 2004. These borrowers would now be paying 11.50 percent. Their EMI has thus gone up by almost 33 percent to Rs 1,066 per Rs 1 lakh for a loan repayable over 20 years. However, new borrowers are still getting loans at around 10 percent. For these new borrowers who are now borrowing at around 10 percent, their discount to the benchmark rate would be much larger than old borrowers. Therefore, these borrowers will always pay a lower interest rate on their borrowed amount.
Here’s why this happens. In a floating rate loan, the interest rate charged is fixed against a benchmark rate, which is called the floating reference rate in the case of ICICI Bank and the retail prime lending rate by HDFC Ltd. The effective rate is fixed in terms of how much below the benchmark rate it is. Thus, if when you borrowed in November 2004 the benchmark rate was 8 percent but you secured the loan at one percentage point discount to the benchmark , your effective rate was 7 percent. The discount of one percentage point to the benchmark rate now becomes fixed. Thus, with the current benchmark being 12 percent, your new effective rate will become 11 percent.
For new customers banks compromise on their margin and increase discount to benchmark rate. A senior analyst said, they increase interest rate on the old customer so that they can give loans at a competitive rate to new customers without compromising on their profitability. HDFC Ltd and ICICI Bank reduced the effective interest rate for new customers in October 2006 from 9.50 percent to 9 percent without reducing the retail rate.