Your Home Loan Interest Rate May Not Fall When Bank Rates Fall, See How HDFC Bank Does It

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Banks are having the last laugh even as they reduce base rates, because they won’t lose money from customers who should, but won’t see a rate cut.  For some of the banks the rate that should “float” – that is, have borrowers pay less interest when the base rates fall – are not going to. For you as a home loan borrower, you should think twice before rejoicing that after SBI, even Axis Bank, ICICI Bank and HDFC Bank have cut base rates; the cut could probably not apply to you.

In particular, Home loans that you “thought” you got from HDFC Bank may not at all change rates. You see, you go to the bank, the banker sells you the loan, you sign the documents and give your money. But you don’t get a loan from HDFC Bank – you get a loan from it’s group company, the big daddy Non-Banking Finance Company called HDFC. This is a different company altogether, and as an NBFC does not even need to have a “base rate”.

HDFC is not the same as HDFC Bank

To understand this better, let’s change the name of HDFC (the non banking entity) to “XXXX”.

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And here is the clincher. While your loan was given to you by XXXX, the HDFC bank – a completely different entity – will then purchase the loan from XXXX. So when you pay XXXX, it deducts a fee and pays HDFC Bank whatever you’ve paid it. Effectively your loan is owned by HDFC Bank and not XXXX, but you don’t know it.

And guess what, because XXXX is a different non-banking entity, it does not need to have a base rate, so effectively even if HDFC Bank reduces its rates, you don’t see it because your loan was originally from XXXX.

Don’t believe me? See this page called “Home Loans” on the HDFC Bank web site. This is the bank site, but it’s peddling loans from HDFC – the logo is different. 

What are you talking about?

RBI mandated base rates for banks. Because banks were using different rates for different people. They were saying look we have existing customers with 10% rates, let them be “benchmarked” to a rate called the “PLR” or a “Prime Lending Rate”. For new customers we will create a “PLR 2” which is also a benchmark rate but only applicable to new customers, so we can get new customers at 9%, but maintain that existing customers pay 10%.

RBI didn’t like this. If it cut rates, then the rate cut would only flow to new borrowers, while old ones are miffed. It then said that all banks need to have a single base rate below which they can’t lend and all “floating” loans should be linked only to this base rate.

Nearly all car loans, personal loans and credit card loans are fixed rate, so they would anyhow remain unaffected by a cut in the bank’s base rates. But housing loans (and many corporate loans) are linked to the base rate, for about six years now.

If the base rate of the bank changes, all loans linked to it change accordingly, and immediately. Till now this was fine because banks were only increasing rates. RBI enforced this rule for banks, but not for non-banking companies, who could have different PLRs etc. Why? Because they don’t get access to RBI funding (repo window) and have to borrow from the market, so they were given a little more freedom.

But RBI did say that if anyone wants to exit a home loan product even from an NBFC and shift to a bank, they should not be charged a pre-payment penalty – this was to improve transmission.

The Rate Cut Cycle Makes For A Strange Issue

As rates fall, you expect that rates go down when a bank cuts rates. But there’s something strange happening, with the likes of HDFC Bank.

HDFC Bank has home loans. But it doesn’t, for the most part, lend directly to its borrowers. 

When you go to an HDFC Bank branch, you can get a home loan. But that home loan comes from HDFC, an entity separate from HDFC Bank. HDFC is actually the home lending non-banking behemoth. HDFC Bank is only an agent that helps “originate” the loan, but HDFC actually lends the money. HDFC Bank gets “processing fees”.

Then, a funny thing happens. HDFC Bank decides it wants home loans too, but it doesn’t lend directly to the consumer. It goes to HDFC, and buys loans from it. It pays HDFC money to transfer the loan to its own books. Then when you pay HDFC the EMI, it takes the money and passes it through to HDFC Bank, and there could be a small fee it deducts.

What that means is: Your loan, which you got in an HDFC Bank branch, and now is owned by HDFC Bank, is actually governed by rates of a completely different issuer: the parent HDFC. In effect, when HDFC Bank cuts its rates, your rates are not cut, as the rate you get is linked to a loan by the parent HDFC, not by the bank.

Turns out other banks have warmed up to this and ICICI Bank too has gone down this way. Monika Halan tweets:

This is incredible, no?

NBFCs Might Cut Too…But Only for New Customers

You would think NBFCs would cut rates too, like banks are.

Correct. But NBFCs can have multiple “PLRs” and have a new benchmark only for new customers. Which means your loan could be linked to an “old” benchmark, while someone else who’s new gets a lower benchmark to deal with. 

What Can You Do?

If you own a loan whose rate isn’t changing (please call and ask), you have only one option: Transfer away your loan.

A new loan from a different bank will give you a lower rate, and no one can charge you a pre-payment or early exit penalty to do so. You can then avail of better rates.

And you can use even an allocation letter from another bank to force your lender to match the lower rates. Most NBFCs charge you money to change the rate, but if you threaten them with closing the loan and moving to a different provider, they will probably put their tail between their legs and remove all charges. Please note: get a confirmed letter from them about the ZERO charge before you do this. If they refuse to give you a letter, transfer your loan out. Do not trust a banker’s word, only the written form.

Is it time for the RBI to act?

Should the RBI make a base rate compulsory for NBFCs too? It should, in my opinion, but the typical NBFC complaint is – they don’t have access to the transmission windows that banks have. NBFCs can’t borrow from the Repo window, so they shouldn’t be regulated as much as banks are.

Which could be true, but it is also unfair if banks own home loans by this roundabout method of issuing them through a partner-group entity, and then buying back the loan, just to avoid the loans being actually floating rate. 

The banks’ defense will be that look, anyway a person can shift loans without a penalty. But it is a huge pain to shift a loan to another bank; and if the other bank also choose to issue loans through a (wink, nudge) group NBFC, then you hit this wall again. 

RBI should stop this regulatory arbitrage, and when banks buy loans from other FIs, either ensure it isn’t a loan from a related party, or demand that such loans can only be bought if they are linked to a single base rate that applies for all loans of the issuer. I.e. NBFCs can have different PLRs if they want, but if they do, they cannot sell their loans to banks. Only single base rate NBFCs will be allowed that liberty. 

What do you think? (Also, do tell me what part of this is wrong. )

Note: As of Sep 30, HDFC Bank had over 19,000 cr. of housing loans on its book, but it doesn’t sell home loans. We do know from their past annual report that they bought Rs. 5,500 cr. of loans from HDFC. This may not be much (it’s just short of 10% of their total retail loans) but it is big enough. 

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39 COMMENTS

  1. That’s a timely brilliant article, in simple language. Thanks !
    This one is going to get a huge number of hits.

  2. Even if loan is routed through bank,rate cut should be enforced for customers because as far as customer is concerned he is only related to bank.How bank routes the loan is there problem.Can bank simply do this at the first place as NBFC and bank are different entities.

  3. HDFC Bank buys loans from HDFC only to fulfill PSL obligations. Only these PSL qualifying housing loans are bought!

  4. I beleive only SBI home loan is pure base rate based home loans(correct me if im wrong). But we all know how painful it is to get it. Personally I chose HDFC knowing this BPLR Vs Base rate type of loan just to avoid huge paper works and ease.

  5. Point nicely explained.

    But all need not jump into loan shifting bandwagon. The 0.5% or so may not be much for the hassle.

    One can take a different view point. If a person pays back his loan in 5-10 years, the rate change by a couple of % point wont impact the total outgo much when compared to complete tenure of 20 years or more. Hence one can concentrate on repayment at the earliest.

      • True. What i meant was for lower tenures the rate may not have so much impact. This is an observation from a practical experience.

        i completed my 20 year loan in 5 years. The rate would not have much impact, in this case, as the principal is being paid off fast.

        • Srinivas – “The rate would not have much impact, in this case, as the principal is being paid off fast.” – on a Rs.10 lac loan, even if you paid off in 5 years, you would pay Rs.15,000 more in interest if the rate remained at 11% instead of going down to 10.5% (when the RBI has reduced by 0.5%)

          That example was for a 0.5% reduction. Now think about the RBI reducing rates by 3-4% over the next few years and you can see how much money borrowers will be losing. Methinks this is a good time to buy NBFC stocks ;-)

          But at a more basic level, it’s not the principal that’s at issue, it’s the principle. :-) If I am signing up for a floating rate loan with the bank, I want to be assured that the rates can go down as well as up, and that it is not a one-way street.

          Deepak – I agree with your suggestion, the RBI should mandate all floating rate home loans should be at a markup to the base rate, and do away with the RPLR rate.

  6. NBFC should not be allowed to issue “floating” rate home loan. Or It should be mandatory to have a base rate for floating loan like banks.

  7. So is the case with education loans provided by Credila (An HDFC owned NBFC). They have a BLR too but as you said, they could start a new BLR. Now, my question is, can’t these NBFCs start new BLRs every other year and keep increasing the older BLRs? Older loans with lower principles will have even less incentive to transfer out the loan. Doesn’t it leave the window

  8. Does this roundabout home loans structure applies to PSUs like Canara Bank, PNB, Central Bank as they have separate HFL subsidiaries?

  9. May be all home loan’s should have a “change of lender” clause. So if the loan account moves to the bank then the bank regulatory provisions should apply. Such clause should require permission of the client to ensure that it doesn’t the other way without the borrower’s consent.

    Then all RBI needs to do is put out a circular insisting this clause be added on a retrospective basis ! House of cards.

  10. look, deepak made a very simple explanation of a complex problem as it exists today.

    in my opinion, no matter what rules the government comes out with, bankers will come out with a different ‘mechanism’ to ‘increase business’.

    what is given is that you, as a borrower, will always pay through all the holes in your body [generall, the nose is used, but there needs to be some progress].

    so, what do all these small rule changes matter, in the medium to long term?

  11. Deepak, I am about to take home loan from ICICI. My home loan sanction letter is on the letterhead of ICICI Bank and it clearly specifies loan as ICICI Bank Home Loan. Further the interest is link to ICICI Bank Base Rate. I reconfirmed these when I applied for the loan since I was aware about the practices followed by likes of HDFC. I am yet to avail the disbursement against this loan sanction.

  12. I’m having homeloan from HDFC Ltd since 2008.From my exp: No sooner govt hikes rates. HDFC promptly increases its RPLR. The viceversa is never true. To prove it, In 2008, the difference (they call it spread) between RPLR(=14.25%) & my interest rate (10.5%) was 3.75%. today my my interest is still 10.5% by I got my spread increased to 3.75+1.5+1=6.25%. (RPLR 16.75%)

    They charged 0.5% of my loan outstanding each of those two times when I got my spread increased (interest rate reduced) by 1.5 & 1%. Its ridiculous that there is no one to question them how their RPLR rate never got to the back to 14.25%.

    They even have got a separate tab on their loan account website called Conversion inquiry module
    Current ROI (% p.a.) : 10.50 Next Reset Date : 01-JUL-15
    Current EMI (Rs.) : XXXX ROI After Reset (% p.a.) : 10.10

    ROI Applicable (% p.a.) Conv.Fees Payable (Rs.)
    10.10 4378 89

    I never understood why they called it floating loan when I actually have to pay money to get the rate reduced.

    -Sachin

  13. I faced the same situation back in 2007-08. I took loan from HDFC and it was not reduced although bank did. Let all home borrowers face this bitter truth. Even if RBI reduces the rates by any percentage (50-1000 bps) or commands banks to lower the PLR by significant percentage, the benefit would never be passed on to common borrowers (general public). The Indian banks are so smart to find some loophole or other to avoid extending the benefit to customers. This wonderful article from Deepak illustrates the point clearly.

    I feel pity, the whole world would be discussing this interest rates revision in emerging markets, business channels and other forms of media blasting this news as big milestone , fund managers and analysit going gung ho about the rates revision, inflation and economy and finally stock markets rallying as if there is no tomorrow for the possible downtrend of rates. I have no words.

    Having suffered myself, am convinced that the benefits of lower inflation would never reach common man on the ground..

  14. What is new in this? The banks are not Non-profit Organizations. They can built NPAs, out of compulsions like Subratos, Mallyas, Marans and the likes. How to compensate the losses then? They should have some mechanism…a small home loan applicant is in not mood to ask any questions, will be ready to bear the brunt…..to compensate the expenditure on bikini babies……why do you bother? madam Bhattacharya herself quoted that a 5% NPAs of SBI are NOT AN INNSUE….You cannot blame a 1000cr. Loanee personally because he took a loan in the name of the company…another politician forces a 8 figure to 10 figure loan JUST LIKE THAT and the banks have to oblige…..After all they have someone to rely upon……

  15. It’s an eye opener. Was thinking of shifting from LIC HFL to nationalized back, now is the time to act.

  16. To plug this regulatory arb, RBI can easily say that all housing loans ‘sold’ by the banks need to be linked to base rate, irrespective to the origin / owner of loan, right?

    • then the banks will stop calling it a housing loan, and call it something else.

      much like the local bank managers will ask you to deploy a bunch of funds as FD if you want a locker. illegal, yes, but does not seem to stop them from asking for it. and yes, no new money, no locker.

      it is intent that matters, not the implementation. rules are more concerned with the implementation part, and so can be worked around every single time.

      wait until the banks start leveraging all the bad loans as CDOs. not sure if they are available in the indian market, but america already had a taste of that.

      look, all the crap that banks have been made to do [in the past 40 years] cannot be washed away within the timeframe of one-two years, which is what Mr Rajan seems to be aiming to do.

      there is going to be a lot of blood before the crime scene is clean. whose blood it is, is anyone’s guess. my guess, mostly consumers.

      irony is that the present government wants more and more people to use banks…

  17. They say the devil is in the detail.
    India had a strong team of Finacial Controllers, starting from FM, the RBI GUV, the IT department, the battery of sleuths, the whistle blowers…..and THE VICTIMS…..but the game between the Prey and the predators is always biased…isn’t it?
    Satyam Scam: PWC simply says it is sorry, it was not aware of the fudgings.
    Sarada Scam: the culprit is allowed to do business from within the cell
    Fodder Scam: the man, the daughters, sons….still enjoying the fodder
    YSR SCAM: the son still enjoys the Leader of Opposition status….
    There is still much more left with the Financial intellecrual Wizardry…..

  18. this could be an issue but the relative size of this market vis a vis the overall size of the housing finance market may not be very large . the bigger issue you are pointing to though is that all those who have borrowed from housing finance companies may not get the advantage of the base rate reduction, whereas all those who have borrowed from banks would. that is the big issue. hdfc and hdfc banks are just side actors in this. that said, competitive forces will play out and housing finance companies will also have to reduce their rates or faces a lot of transfers to banks, who are today very aggressive in home loans coz corporate credit growth is very weak.

  19. Nicely explained. I bought a loan from LIC HFL at 10.10% for 20Y. I need to plan this out in a way that won’t cause regret. Anyone else who’ve had previous Loan experience with LIC HFL and how you dealt with these things?

  20. If this is true, How the HDFC inreases rates multiple times, Then why old loan are called Floating. If this is to lure the new costomer & once loan sectioned, the HDFC can increase only.

    It does not look sensible for anyone, neither for HDFC nor for us & Also for whole country, such a great loot is cont. going on…infront of so many reguatory institutions/RBI etc. in name of signed papers during approval of loan (No one read such thing) , they get signed in name of RBI rules.

  21. This is very true.
    I have a 20Y home loan from HDFC Ltd. As soon as RBI increases the rate, HDFC immediately increase the rate.However on the other hand, when RBI reduces the rate, there would be no news on reduction whatsoever.

    This time I lost my patience and wrote a query to them on why the interest rates were not reduced and was shocked to get this response (see below)

    Aravindh
    Thank you for posting your query on our website.
    Query : Why there is no reduction in interest rates despite RBI reducing the REPO rates now two times in a row?
    Answer : Repo rate applicable only for banks & not for housing finance companies

    I really did not know before that these are NBFC and they need not reduce the interest rates based on the rates set by the RBI – So lesson learnt hard.
    My next loan would be from a proper bank only not from any NBFC.

  22. Same problem with Indian bank as well, even they are not reducing, now i am paying ROI is 10.25

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