Published: Dec 3, 2021, 9:26pm
For everyone, the first choice that comes to mind when looking to finance their home purchase are loans from commercial banks. However, along with banks, there are other options to finance your home loan. Over the past decade, the sector of housing finance companies has evolved considerably in terms of financial stability and profitability.
The rise in affordability, growing population and other industry favorable dynamics also contributed to the growth of housing finance companies (HFCs) in the past few years. During 2013-18, housing finance companies (HFCs) grew over 20% fueling high-risk products such as loans against property and builder loans. Also, in the Union Budget 2019-20, HFCs were handed to the Reserve Bank of India by the central government to avoid any crisis-like situation. This means even though HFCs are entities owned by the National Housing Bank (NHB), they have to follow all the guidelines set by the RBI. As a result, there are high chances of you coming across HFCs while looking for the right home loan provider.
If you are planning to take a home loan, you will have two options: banks, which is the traditional and often a primary choice or a non-banking housing finance company (HFC). While interest rate plays a significant role in deciding the financial institution, many factors set banks and HFCs apart. On the surface, both options might seem similar but both have their differences based on the regulatory and fund sources.
Here are the advantages and disadvantages of both based on key factors such as interest rate, ease of borrowing, processing fees, repayment structure, eligibility criteria, among others.
Both HFCs and banks come under RBI regulations, however, they still have their method of calculating home loan interest rates. Let’s try to know two related terms before we get into details. The HFCs follow a prime lending rate (PLR) and a discount on the same, and banks offer their interest rate based on marginal cost of funds based lending rate (MCLR).
Interestingly, the method of calculating PLR is not clear, however, the idea remains to raise the funds along with a certain profit margin. For instance, if the PLR of HFC is 14.05% and the discount decided on the same is 5%, the interest rate comes out to be 9.05%. It is important to note that each HFC decides their discount.
Whereas, banks have their method of interest rate calculation which is regulated by the RBI. They start by calculating the base rate (which includes the profit margin) decided by RBI and add a spread to the base rate/MCLR. For instance, if the base rate is 7.5%, banks will add on their spread on the same, let’s say 0.5% making the final lending rate to be 8%. Bound by external factors, banks cannot go beyond the decided base rate, however, HFCs have the freedom to increase or decrease the rate to suit customer demands.
However, this also means that banks are faster than HFCs in passing on interest rate changes to their customers. Simply, because the RBI ensures that rate cuts are passed to the customers quickly without any hassles. As a result, the person who has borrowed a loan from the bank would invariably pay a lower interest as compared to the HFC.
The documentation process is much simpler and less stringent in the case of HFCs. It requires less paperwork and has a rapid process as compared to banks. Hence, for borrowers, the turnaround time to process the application is also quicker.
If you are applying for a home loan and your documents are not in place, you might face trouble getting a home loan from banks. Since banks follow a set of rules and procedures set by RBI, they cannot go easy on borrowers.
However, HFCs will have the flexibility while approving your home loan applications. So, in case you fail to get the home loan approval from the bank (unable to meet eligibility criteria or so on reason), you will always have a choice to approach HFC.
A common notion of taking a home loan HFCs after getting rejected can be ignored when it comes to certain circumstances such as taking a higher amount. HFCs are suited for a lot of borrowers seeking to take up a higher loan amount, as compared to banks.
As banks usually refrain from including stamp duty and registration costs while evaluating property’s market value. However, the case is different with HFCs as they are flexible on taking the stamp duty and registration cost in the total cost of the property. So, in a country where these charges can be as high as 5% to 6% can still make a lot of difference.
As a top-up on your existing home loan, banks provide an overdraft facility giving you the freedom to manage your planned or unplanned expenses. As we all know that a home loan is a long term commitment and during that period, a borrower faces many ups and downs. This is where having an overdraft facility helps. For instance, you have taken a home loan of INR 1 cr at an interest rate of 7.2% for a tenure of 20 years. Over the complete tenure, you will end up paying interest close to INR 90 lakh, which is the amount that you have borrowed.
An overdraft facility helps you to avoid hefty interest payable by parking surplus funds to the loan account. These funds can be treated as a prepayment towards the home loan lowering the overall loan liability. Also, the borrower can withdraw the deposited surplus funds whenever required to maintain liquidity. This facility is only provided by banks and is not available with the HFCs.
Your credit score plays a big role in representing your credit history, numerically. Those who have paid all the EMIs and debts timely without depending on anyone are likely to have a good credit score. If your score is 750 and above, you are seen as a favourable borrower for a home loan. And, as mentioned above, banks have strict policies when it comes to approving a home loan. This is also true concerning credit scores. Banks only provide home loans to those who have unquestionable credit scores whereas HFCs are comparatively lenient and more open to applications with a low credit score.
HFCs set their credit score models and parameters to check your creditworthiness. So, in a case where you are being rejected for a home loan due to a low credit score, you still have a chance to get it approved by HFCs. However, both have their pros and cons. Getting a loan from HFCs in the time of need might increase your chances but at the cost of a high-interest rate. Contrary, banks might need a good credit score but you will get to negotiate the higher amount at a lower rate of interest.
It is not so easy to declare the right choice, especially when both have their advantages. But what you should do is first evaluate your actual loan requirements and then make the right decision. Earlier, the steep interest rates of housing finance companies used to give the banks an edge, however with time the gap has significantly reduced.
If you are someone who has a low credit score and has no plans to improvise it, then HFC comes to the rescue due to their relaxed policies. On the other hand, if you can wait a bit longer to improve your eligibility criteria and credit score, you may go for a bank home loan. As per a report, during the Covid-19 pandemic, the RBI’s repo rate touched 4% in May 2020, which is the lowest since 2001. As a result, there was a decline in home loan rates as well, to as low as 6.7%. To enjoy such rate cuts, it is always suggested to get a bank home loan which is regulated by the RBI.
Lets try to understand by using an example, a person who took a home loan of Rs 1 cr was charged with an 8.2% interest rate. In the next six months, the rate dropped to 7.3%. Now, if he is a bank home loan borrower, he would enjoy the 0.9% interest rate cut saving him a lot of money.
In the case of HFC, as rates are benchmarked to PLR, to give benefits to new customers, they increase the discount on PLR. However, existing customers do not benefit from the same. But again, the choice between the two is totally up to the borrower. Keep in mind the above-discussed factors before coming to any conclusion. It will help you to compare right depending on your eligibility and requirements. The best way remains to visit online financial marketplaces and compare various loan offers available to them.
There are chances that you might be paying a higher interest rate as compared to what new borrowers might be getting. If your current loan is with a bank, it is possible that your bank might offer you a rate reduction. From October 2019, the RBI asked all banks to link their floating interest rate to an external benchmark. This change helps the borrower to know whenever there is a rise or fall. But if you are looking to increase your LTV ratio, then you always have a choice to transfer your home loan to an HFC institution. If you are already with HFC, it would make sense to shift to a bank to take advantage of external benchmarks.
The idea is to keep an eye on what home loan institutions are paying to their new customers and the rate you are paying. If there is a difference, you always have a choice to convert to a lower rate after paying the conversion charges depending on the institution. That said, a borrower who is unsatisfied can always switch to a new lender. However, there are some costs attached when transferring the home loan balance. Among the major charges, there are processing fees, stamp duty, legal and technical fees.
Therefore, switching decisions must be taken carefully. As said by experts, it only makes sense to get your loan transferred if your existing tenure is left for more than 10 years. This is because you pay the larger part in the initial years of the loan. If a borrower has less than 10 years remaining for the loan, it might not be a good idea. Hence, evaluate all the savings before doing so.
Atul Monga is the co-founder and CEO of BASIC Home Loan. He is an ex-investment banker, technopreneur and a fintech specialist.
Armaan is the India Lead Editor for Forbes Advisor. He has more than a decade’s experience working with media and publishing companies to help them build expert-led content and establish editorial teams. At Forbes Advisor, he is determined to help readers declutter complex financial jargons and do his bit for India’s financial literacy.
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