In a floating-rate home loan, the interest rate is not fixed (representational)
Reserve Bank of India (RBI) has announced a transparent framework will be introduced to reset interest rates on floating-interest loans such as home loans. RBI Governor Shaktikanta Das made the announcement at the central bank's bi-monthly monetary policy meeting on Thursday.
In a statement on 'Developmental and Regulatory Policies', RBI said that all regulated entities will implement a proper conduct framework to address the issues faced by borrowers and detailed guidelines in this regard will be issued shortly.
But what exactly does this step signify and how will it impact home loan borrowers? Let's take a detailed look.
What is a floating rate home loan?
In a floating-rate home loan, the interest rate is not fixed and keeps varying over the tenure of the loan. The interest rate depends on market dynamics and is linked to a benchmark rate. Borrowers opt for a floating-rate home loan if the interest rates are expected to fall in the future.
In India, banks have the freedom to offer all categories of loans at fixed or floating rates. The methodology of computing the floating rate is objective, transparent and mutually acceptable to counterparties. The base rate or the external market benchmark rates serve as the reference benchmark rate for floating rate loan products.
What is the need for the new transparent framework?
Until recently, the RBI had been raising the repo rates in order to contain inflation. With a rise in repo rates, the floating rates too increase. This translates into higher EMIs (equated monthly instalments) for borrowers. But it has been found that instead of asking for higher EMIs, some banks are simply increasing the tenure of the loan without informing the borrower.
This is making loan repayments unreasonably long and without proper consent from borrowers.
So what is RBI suggesting now?
In order to strengthen consumer protection, the central bank is now putting in place a framework where banks would need to clearly communicate with borrowers any resetting of the tenor and/or EMI of the home loan well in advance.
Also, RBI has asked lenders to offer borrowers an option to switch to fixed-rate home loans or foreclosure of loans whenever they want.
Banks would also need to disclose various charges incidental to the exercise of these options beforehand to borrowers.
This would result in borrowers taking a more informed and calculated decision while repaying their home loans.