Ms Bhattacharya, teaser rate home loans are a bad idea

Aug 26, 2015

- By Vivek Kaul

Vivek Kaul
The recent suggestion by the State Bank of India (SBI) Chairperson, Arundhati Bhattacharya, to get back teaser rate home loans into the system, has once again sparked the debate over this controversial product. Bhattacharya recently said at an event where the Reserve Bank of India governor Raghuram Rajan was also present: "In fact, the first suggestion that I made (was) that, for a limited period, home loans could be given at below base rate for the already heavy stock of housing."

In early 2009, SBI had started a teaser home loan scheme at 8%. Bhattacharya went on to add: "Of course, at that time, it was tagged as a 'teaser', but, we at SBI, refute that because the due diligence conducted for those loans was same as for others. Even the eligibility (criteria) was same as for regular loans."

Teaser home loans are essentially home loans in which the interest rate is fixed in the initial years and is lower than the normal floating interest rate on a home loan. The lower interest rate is limited only to the first two-three years after which the loan is priced at the prevailing interest rate on home loans.

For example, the interest rate on a teaser home loan may be fixed at 8% for the first two years, when the prevailing home loan rate is 10%. From the third year onwards, the prevailing interest rate on home loans is charged to the borrower.

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The idea with teaser rate home loans is that at lower rates of interest initially, the EMI will also be lower. This will encourage more people to take on a home loan and buy homes. This Bhattacharya feels will help in clearing the inventory of unsold homes that has piled up all over the country. As she said: "Today, the base rate is 9.7%. I am told that real estate inventory is at a two-year high and I was thinking if it is possible for a little while... could something of this (teaser loan) kind be allowed."

There are multiple problems if anything of this sort were to become a reality. First and foremost, is it the job of the nation's largest public sector bank to help real estate companies' clear unsold inventory? From whatever little I have learnt on how banks should operate, the primary objective of a bank is to lend to those who are likely to repay and also, make money in the process, without increasing the overall riskiness of the financial system. Second, why should a bank be allowed to lend below its base rate or the minimum interest rate a bank charges its customers?

Third, if a bank gives out a teaser rate home loan at let's say 8%, is it making money on that lending? And if it's not, why is it lending in the first place?

When SBI first started offering teaser rate home loans in February 2009, under the leadership of OP Bhatt, it received criticism from all fronts. Teaser loans were a major reason behind the financial crisis that had started in the United States in September 2008. The difference in the Indian and the American context was that the teaser home loans that SBI was offering, were nowhere as aggressive as the teaser home loans that had been offered in the United States.

In the American context some teaser loans were so structured that only a certain amount of interest had to be paid in the first few years. Hence, the difference between the initial EMI and the actual EMI which kicked in after the "teaser-rate" was over, was huge. Hence, it led to huge defaults. That wasn't the case in India.

Nevertheless, given the environment in the immediate aftermath of the financial crisis, the teaser home loan did not go down well with the banking regulator. Also, as we shall see, a certain amount of risk did remain in the product. Further, even though, the other lenders such as HDFC, ICICI Bank etc., joined the teaser loan bandwagon and started offering teaser loans, they made it amply clear that they were only responding to competition.

In fact, Deepak Parekh, Chairman of HDFC had called teaser loans a "marketing gimmick". He had also explained why the product remained risky, even in an Indian context. As he told the Mint newspaper in an interview: "Today what we are saying is, if it's 8% or 8.25% for the first two years, the rate will be 9% afterwards and so the gap is very little. Suppose interest rates in India shoot up in the next three years, then what will happen? These are all floating rate loans and fixed only for first two years. So, 8% interest will become 12% or even more. Then, the gap will be too much and it's a problem for the individual home-owners."

And home loan interest rates did rise eventually in the years to come. There is no data available in the public domain to figure out what was the impact higher interest rates had on those who had taken on a teaser loan.

Further, as Parekh explained: "Financial innovation doesn't take time; if one does it, everyone copies. It can be done in 24 hours." If SBI were to launch a teaser rate home loan right now, every other bank would launch a similar product in quick time. This would increase the overall risk in the financial system.

Given all these reasons, teaser loans are a bad idea. And it is surprising that the idea to re-launch them has come from the head of the largest bank in the country. The good news is that it is unlikely that Raghuram Rajan is in the mood to listen to this suggestion. In fact, he made it clear recently to real estate wallahs (real estate companies, lobbies and others associated with the sector) that they should stop asking for lower interest rates every time they open their mouths to speak. He asked them to start cutting prices instead.

As Rajan said: "It would be a "great help" if realty developers sitting on unsold stock bring down prices...Once the prices stabilise, more people will be keen to buy houses...I think we need the market to clear. With growing unsold stock, we need to see the ways to do it. Some of it might be by making loans easier, but we also don't want to create a situation where prices stay high at the level which means demand can't pick up."

Also, as I have said many times in the past, real estate prices are at a level, where slightly lower EMIs really won't make much of a difference. The real demand for homes to live in will only come in once builders start to cut prices.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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13 Responses to "Ms Bhattacharya, teaser rate home loans are a bad idea"

Prasad

Aug 27, 2015

Very good points raised by author. This article shows the mentality of a leading banker which is not in the best interest of its depositors and shareholders. Is she speaking under pressure from someone influential? May be. If Rajan is pressurized so much to cut rates, imagine how severe pressure would be on others.

Like (1)

Nerkuppai Thumbi

Aug 27, 2015

Dubious expenses (i.e. expenses recorded as to have been made under agreeable heads, a.k.a bribes given to the government machinery at various stages) contribute a sizeable part of the Cost and hence expected Selling Price of the house. The worst part is none of it is refunded if the Selling Price is reduced for economic reasons. Well, this cost of construction needs to be addressed: There is no sign that it will go down in the near future; in fact, the babus are adept at hiking it, in the name of additional risk due to say, Anna Hazare or Kejriwal!

Like (1)

Thumbi

Aug 27, 2015

We strongly object to calling them Teaser loans.

2. The house/flat is in the making and is yet to generate income or indirect income by reducing expenditure to the buyer; a lower rate is not out of place.

3. The SBI Chairperson heads a bank, which has more than its share of bad loans given to Home Loan borrowers, Construction companies and several in the manufacturing-supply chain of building materials. Unsold inventory affects everyone in the chain.

4. True, another and perhaps better solution will be for the builders to reduce the price; well, easier said than done: bubble or whatever, the lands have been bought at such prices and construction/value-addition done on estimated selling price.

Like (1)

Deepak

Aug 26, 2015

With lower rate of interest for 2-3 years, a buyer can afford to purchase an under construction property and when EMI increase he may be still comfortable to pay as he might be saving on rentals. Also in 2-3 years his family earning might increase as is mostly the case with salaried people and even business people. So assuming they will default once EMI increases is highly incorrect.

Like (1)

sitarama

Aug 26, 2015

TeaserHomeLoans? Definitely not a good idea. The real estate sector, especially residential housing and more specifically for the middle class (the so called affordable housing), needs correction in prices. The small advantage in the interest in the first two or three years may entice some of the unwary to buy; but such loans are an incentive to the builders and not to those who are in need of housing. Given the very large inventory with the the builders they should come forward and reduce the prices.

Like (1)

B. Ramesh

Aug 26, 2015

Mr. Bhattacharyas comments r very correct. Whooping EMI after expiry of teasing period willbe a burdon to common man. In this context I suggest that a mechanism should be developed in respect of pricing ofdwelling houses.

Like (1)

S P Dhanaraj

Aug 26, 2015

I was a victim of teaser mortgage loan of LICHF . Initial ROI was 12.50.However over short period of time,the rate went upto 13.75. The rate was never brought down. I closed it paying penal interest of 2.00.do not get carried away by low rates at the initial stages.

Like (1)

Deepak

Aug 26, 2015

There is nothing new in the article except the pessimism and blame on real estate developers without understanding the problem in the sectors. Anyways the highest quoted properties in NCR or elsewhere are driven by black money and not developers.
Simply investors are out of the market and even though prices in Gurgaon (example) are lower than what they were 3 years back, no one wants to buy as people believe prices will not move up even if they delay purchase by another 6 months.

Like (1)

HB

Aug 26, 2015

Hi Vivek, you're asking why SBI is keen to support liquidation of unsold inventory .... any bets on SBI being neck-deep in direct lending to these very builders, and SBI being happier to string debt onto the SMALL individuals rather than face the prospects of the BIG builders defaulting ?

Like (1)

Ganeshkumar

Aug 26, 2015

Dear Vivek,

As usual, your article is very precise and up to the point.The real issue is the prices are high and the middle calss is not able to buy a home at current prices
But, can you also speak to the real estate bodies and understand why they are not or why they are not able to cut down prices ? We can have their views also and see if it is genuine.Thanks

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