When the Reserve Bank of India (RBI) announces a rate cut, borrowers with home loans from banks often see their EMIs decrease within weeks. However, those who have borrowed from Housing Finance Companies (HFCs) may not experience the same benefit, or may have to wait months to see a reduction in their EMI. This discrepancy is due to fundamental differences in how banks and HFCs operate.
Banks raise funds primarily from customer deposits, which gives them access to low-cost capital and allows them to offer lower interest rates. They are also required to link new floating-rate home loans to an external benchmark, such as the RBI’s repo rate, which ensures that changes in policy rates are transmitted quickly to borrowers. In contrast, HFCs raise funds from banks or the market at higher costs, and their lending rates are often pegged to their own internal benchmark, the Prime Lending Rate (PLR), which they adjust at their discretion.
As a result, HFC borrowers may face delays in seeing the benefit of a rate cut, and the reduction may be smaller than the headline cut. Additionally, HFCs often have longer reset periods, typically six to twelve months, which means that borrowers may have to wait longer to access lower rates. To switch to a lower rate, HFC borrowers may need to request a conversion and pay a switch-over fee.
The impact of a rate cut on a borrower’s EMI can be significant. For example, a cut of 0.25 percentage points on a Rs. 50 lakh loan for 20 years can reduce the monthly EMI by about Rs. 820 and total interest costs by nearly Rs. 2 lakh. However, the size of the rate cut announced by the RBI is only half the story, and the other half is whether, when, and how the lender passes on the benefit.
When deciding which lender to borrow from, borrowers should consider factors such as interest rates, loan sanctioning processes, and credit score requirements. While banks may offer lower interest rates and faster transmission of rate cuts, HFCs may be more accommodating for borrowers with low credit scores or irregular income. Ultimately, the decision comes down to striking a balance between cost and convenience.
Experts recommend that borrowers should be aware of the trade-offs involved in choosing an HFC over a bank, such as slower benefit from rate cuts, potentially higher interest costs, and fees for switching or converting rates. Proactively reviewing loan terms and monitoring interest rate movements can help maximize savings.
To address the remaining gaps between banks and HFCs, experts suggest that HFCs should be required to use external benchmarks that speed up rate transmission for their customers. Standardizing reset cycles, improving disclosure of the “true” annual percentage rate, and making it easier and cheaper for borrowers to switch lenders would give consumers more power to make the choice that suits them best. The ultimate goal is a housing finance market where the decision between a bank and an HFC is based purely on service and borrower fit, not on who will pass on an RBI rate cut first.