All you wanted to know about teaser home loans

September 19, 2015

At a recent banking conclave, SBI chairperson Arundathi Bhattacharya wondered if banks could re-launch discounted home loans to revive the floundering property market. RBI governor Raghuram Rajan neatly fielded this by saying that it would be better if builders dropped their prices instead.

India’s largest bank and the regulator have been at loggerheads over the so-called ‘teaser home loans’ ever since these products were first flagged off in 2009-10.

What is it?
This is the unofficial term used to describe housing loans that carry ultra-low fixed rates in the initial years, but charge market-linked rates thereafter.

Normally, most Indian NBFCs and banks offer home loans at floating interest rates. The interest rate on the loan is at a ‘spread’ over the lender’s base rate. As the base rate changes, the interest dues on the home loan jump up and down over its 15- or 20-year term.

In 2009-10, SBI flagged off a novel home loan scheme with interest rates that were fixed at 8 per cent for the first year and 9 per cent for the second and third years. From the fourth year onwards, the loan morphed into an ordinary floating rate loan. This scheme was termed a ‘teaser loan’ scheme by market players because it lured the borrower with low rates in the initial years, only to bump up the rates later.

But the RBI was quite unhappy with this trend. Given the yawning gap between the teaser loan rates and market rates, the worry was that teaser loans would expose banks and lenders to a high incidence of default.

RBI discouraged such loans by sharply hiking the mandatory provisions for banks, against such teaser loans. Home loan companies began to phase out their teaser loans by 2011 and SBI finally withdrew the product in April 2011.

Why is it important?
Home loans are one of the few categories of loans in India where banks face a very low incidence of default, even amid NPA epidemics like at present. The worry is that a teaser home loan, by offering borrowers ultra-low rates in the first few years, may tempt them to take on a far bigger housing bet than they can afford. In a rising rate cycle, a transition from a fixed to a floating rate can well throw a salary-earner’s EMI calculations out of kilter.

In 2009-10, RBI’s worries on this score were aggravated by the US housing and credit crisis in which several US mortgage lenders had gone bust after extending generous low-priced home loans to sub-prime borrowers.

This time around, interest rates seem to be headed down instead of up, which might actually work in favour of the teaser loan taker. But the Indian property market is today on shaky ground with falling new home sales, mounting inventories and cash-strapped builders. A collapse in property prices could easily land home buyers and their lenders in a soup if teaser loan schemes prove a runaway hit.

Why should I care?
If you’re a smart investor, you can make the most of teaser home loans by borrowing at discounted rates when interest rates are sky-high and switching to a cheaper loan when the offer period ends.

By taking on a teaser loan, you are essentially taking a wild card bet that your income will keep up with your loan repayments for 10-15 years.

The bottomline
Are you smarter than your bank? If not, teaser loans are not for you.