Stop Charging Prepayment Fee on housing Loans : RBI Asks Banks

The RBI (Reserve Bank of India) on  recently asked banks to immediately stop charging penalty on prepayment of housing loans taken on floating interest rates.

RBI said in a communication to banks,  It has been decided that banks will not be permitted to charge foreclosure charges or prepayment penalities on housing loans on floating interest rate basis, with immediate effect.

Mr. Damodaran  committee..!

The RBI noted that the Mr. Damodaran (SEBI Ex - Chairman) committee had observed that foreclosure charges levied by banks on prepayment of housing loans were resented by housing loan borrowers. This is particularly so considering that banks were found to be hesitant in passing on the benefits of lower interest rates to the existing borrowers in a falling interest rate scenario, it added.

In fact, since October 2011, HFCs (Housing finace companies) like HDFC, LIC Housing Finance and DHFL stopped charging prepayment penalty, following an order from the regulator, the NHB (National Housing Bank).

As such, foreclosure charges are seen as a restrictive practice deterring the borrowers from switching over to cheaper available source, RBI said.

The removal of the charges or penalty, RBI said, will lead to reduction in the discrimination between existing & new borrowers and competition among banks will result in finer pricing of the floating rate housing loans.

Though several banks have in the recent past voluntarily abolished prepayment penalties on floating rate housing loans, there is a need to ensure uniformity across the banking system, it added.

Differential Floating Housing Loan Rates..!

With the removal of prepayment penalty on housing loans by banks, the RBI has abolished the possibility of banks having differential floating housing loan rates of interest for old & new customers.

Banks like SBI (State Bank of India) made the concept of teaser rates very popular, where, new borrowers would be charged a rate of 9.10 per cent for the first two to three years, following which, the then-prevailing floating rates of interest would apply.

With an increasing interest rate scenario &  aggressive competition in the sector, several other banks and HFCs  followed suit, promising rates of 10.25% to 11.25% for the first 3 years, when the prevailing floating rates were at above 13%, in September last year (2011).

The past  7 to 8 months had not seen any major bank or HFC offering teaser housing loan rates, although, they were not legally barred from doing so. But now, with interest rates required to be uniform for old &  the new customers alike, according to RBI's regulations, the concept of poaching customers from other banks by offering lower rates for the first few years may not be possible, unless, banks offer their existing customers the same low rates of interest.

Long Term Loans...!

This step by the regulators (RBI and NHB) will make banks and HFCs focus on specialisation by offering better products than focusing only on financial reengineering. It will also make the customers look at the entire life of the loan rather than just evaluating the lender at the time of taking the loan. Housing loans are long term loans, and therefore, after disbursement, servicing will become a crucial differentiator.

Now that the prepayment penalty has been taken off, it is easier for customers (Housing loan takers) now to move to another borrower at no extra cost. With interest rates set to fall from now on, banks can not charge lower floating rates for new borrowers &  retain the higher interest rates for old borrowers.

The removal of the prepayment penalty &  foreclosure charges applies both to prepayment by the borrower from his/her own sources, as well as through loans from another bank or lender or HFCs

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