Thursday, April 21, 2011

Why RBI hates teaser loans,

At a time when people were afraid of lending money to one another, SBI came as a knight in shining armor to save them not only by lending them money; but by lending to them at a lower rate. They brought the concept of teaser loans- where a person would be charged a lower rate of interest in the first few years after which the rates would be normalized. This became a rage for consumers all over the country and everyone wanted a home as they could "finally" afford one. However, they seemed to have forgotten one small detail. “What would happen when the rates normalized? Would they be able to afford the higher EMIs?”
The bank's strategy was good if the customers they chose would also be able to afford the burden of the higher EMIs later on. Customers profited as they got loans at lower rates and the bank profited as more and more customers flocked to the bank for loan disbursement.
RBI’s fear of this causing a sub-prime like situation is not without reason. If the bank has given loans to people undeserving or unable to pay higher rates later -- it may well become a big problem for the bank and the customers since about 40% of the bank’s loan book today consists of teaser loans. For the customer, it may become an even bigger issue, where he may lose the property he has been paying for -- if he is unable to bear the higher EMI.
The customer would be wise to provide for the higher EMIs earlier rather than waiting for the sudden shock. He can start by saving money immediately on taking the loan and investing it in instruments like debt funds or even equity funds (where the tenure is 3 years) on a monthly basis from where he can withdraw and provide funds when the additional EMI kicks in. The customer should at the time of taking the loan (or even now) work with the bank and evaluate what is the likely increased EMI going to be so that it doesn't come as a rude shock later.
It would be good if the bank offers various alternatives at the time of normalizing the rates- like increasing tenure, increasing EMIs slowly rather than at one time.
However, if bank has chosen the borrowers wisely, it has been a great product especially for the younger borrowers. They had lower incomes earlier, and hence lower EMIs; and as their income levels increase, so will their EMIs. It was an ideal product for the disciplined and the ones who can afford it. Each product has criteria that suit a particular type/ category of people: the teaser loans were no different.
Whether teaser loans will cause any damage to the bank or to the customer- only time will tell.


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