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All about “teaser rate” home loans – And what its end means for you

Some of the large banks in India have announced that they are stopping the “teaser” rates for home loans. Is this good for you, or bad? How does this effect you? Find out!

Recently, some large Indian banks announced that they would end the home loan schemes offering a “teaser rate” to their customers with effect from 1 December, 2010.

What does this mean for you, as a home loan seeker? Let’s find out. But as usual, let’s start with the basics!

 

Home Loans: Fixed and Floating Interest Rate

These days, most home loans are given out with a floating rate of interest – as and when the interest rate changes in the market, the interest rate on your home loan also changes.

(To know more about home loans and their income tax benefits, please read “An introduction to home loans and factors to consider” and “Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage”)

Fixed rate home loans are also available, but there are some banks that do not offer them at all, and there are some banks that offer them only for lesser tenures (say for loans of up to 10 years).

Even when fixed rate home loans are available, the interest rate for them is significantly higher than the floating rate home loan – at times the difference is 2.5%!

So, it is no wonder that these days, most home loans are taken with a floating rate of interest.

 

What is a “teaser rate” home loan?

A home loan with a teaser rate is a floating rate home loan with a twist – the rate of interest is fixed (and quite low) for the initial 2-3 years.

After this period, the rate changes to a floating rate – which means that you pay the prevailing market rate for your home loan.

For example, the loan may offer a special concessional rate of 8.5% in the first year and 9.5% in the second, followed by floating rate for the remaining years (which can be about 11.5% as of today).

 

The advantages of a teaser rate home loan

The logic behind such loans is very simple – since the rate of interest is low in the initial years, the EMI (equated monthly installment) is also low.

This means that more people – especially young people – can afford to take a home loan and purchase a house.

(It is an excellent idea to buy a house as soon as you can in your life. For more details, please check out ““Settle” early in life – buy a home when young”)

 

The disadvantages of a teaser rate home loan

But it is not as simple as it seems.

The problem is: What happens when the market-linked floating rate kicks-in after a couple of years?

All is well if the prevailing rates have gone down – the EMI would reduce, and you are happy.

But what happens when the rate of interest has gone up in the economy? (As is the case today – please read “Interest rates in India moving up – Deposit and lending rates increased by leading banks” for more)

When the floating rate becomes applicable, there would be a sudden jump in the EMI payable by you. Would you be able to pay this suddenly increased EMI?

The answer for many people would be “no”, especially because most people take the maximum possible home loan, so that they can buy the best possible house. So, they are already stretched! When the EMI increases in such cases, servicing this new EMI becomes almost impossible.

This is a problem even for the banks – in the race to get business, the banks might be a little lax in their loan processing. They might have checked your creditworthiness based on the initial, low teaser rate. But if you don’t remain credit worthy after the floating rate kicks-in and are not able to pay the EMIs, the loan becomes a problem for the bank.

And remember, this problem can arise even if the prevailing rate of interest stays where it was. Remember, the teaser rate is a lower rate compared to the prevailing market rates. So, even if the prevailing rates remain where they are, the EMI would increase when the floating rate becomes applicable!

This is a BIG drawback of teaser rates – and even the Reserve Bank of India had made its concerns very clear about such home loan schemes.

 

The example of USA

The fear expressed above is not hypothetical, its very real. And the current crises in the USA had a lot to do with such “teaser rate” home loans.

There, many such loans were given out to people who couldn’t afford the actual floating rate. But when such rates kicked in, these people just took out a new home loan with teaser rates – this was easy, as the prices of their houses were increasing.

But when the prices of their houses stagnated (and then started going down), they couldn’t take out new home loans. And they couldn’t pay the high EMIs based on the floating rate.

And that was one of the main reasons for the credit crises in America!

 

The end of the “teaser rate” home loans in India

As we saw above, some large private and public sector banks in India have decided to stop these teaser rate home loans. These include:

  • ICICI Bank
  • HDFC Bank
  • Corporation Bank

Most other banks are expected to follow them and stop the teaser rates.

Since these banks have a large presence in the home loan market, we can say that the era of “teaser rates” is now over in India.

(Whether State Bank of India (SBI) – another large home loan player and the bank that started the concept of teaser rate home loans in India – would follow these banks is not yet clear, though)

 

What are the implications for you?

Do you think you have missed the opportunity or chance to get a home loan at attractive rates? Or are you better off now?

Yes, a teaser rate home loan is quite tempting due to its lower initial EMI. But as we saw above, there is a huge – and real – disadvantage. So, it was never a right decision to opt for a teaser rate home loan. It was tempting, but it was not good.

Therefore, the end of teaser rates is a good development. You can say that one of the “temptations” has been removed from the market!

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