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Why High Interest rate on Home Loan for Existing Customers? Research Team | Posted On Tuesday, July 14,2015, 06:02 PM

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Why High Interest rate on Home Loan for Existing Customers?



The month is over. What a relief. But wait there is a home loan to repay. Those EMI’s come up so fast. All my money is spent paying the interest on that home loan.It has been a few years since I have been repaying the home loan. Then one day I got a rude shock. My friend who just availed a home loan of similar tenure and amount in the same bank pays a lesser interest than me.I felt cheated by the bank. I had availed my home loan 2 years earlier and I was paying a higher interest on it, than my friend.Why high interest rate on home loan for existing customers? I made enquiries with a few friends and came up with a surprising answer.

The home loan I availed was a floating rate home loan. This means my home loan interest rate, rises or falls with the market rate.

Banks have a base rate, which is a minimum rate below which the bank will not lend. Banks are free to decide the base rate based on their cost of funds.

Different banks offer different rates on their deposits and if your bank offers you a higher interest on the deposits, you place with them, then the bank would generally have a higher base rate. This means banks would charge a higher interest to those to whom they lend.

Banks fix the base rate based on their cost of funds. (The interest banks pay on the deposits with them).

The lending rate of banks on a home loan

Banks fix the interest rate for your floating rate home loan based on the base rate + spread.

The spread is basically the margin of the bank. The bank has administration expenses and other expenses. The margin of the bank includes these expenses and a profit. 

Margin = Expenses of the bank + a profit.

If the bank has a base rate of 10.25% and fixes a spread of 0.5% the bank is charging you an interest on your home loan of 10.75%.

If the market rate falls (there is a cut in repo rates), the bank may reduce your base rate by 0.25%.The new base rate is 10.0%.

The bank does not reduce the spread (margin it gets on your home loan).It continues to charge a spread of 0.5%.

The new rate on your home loan is 10.5%.

But my friend pays a cheaper interest rate on the home loan

The bank offers your friend a lower rate of interest as he is a new customer for the bank .The new base rate of 10% is same for both of you, but the bank can reduce the spread (margin of expenses and profit), for your friends home loan.

The bank charges a spread of only 0.25% for your friend, in order to entice him to avail a home loan with them. He pays an interest of only 10.25% on the home loan, while you pay an interest of 10.5% on your home loan with the same bank and the same amount and time period.

This method is widely used by banks to entice new customers to avail home loans with them.Know you know why high interest rate on home loan for existing customers is charged.

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