Should I take Loan from a Bank or a Housing Finance Company

With banks and Housing Finance Companies (HFC) both providing home loans borrowers are sometimes confused as to whom they should take the home loan from. Let us discuss the peculiarities of both.

Basis of interest rate charged and movement

All the housing finance companies are regulated by National Housing Bank (NHB) whereas banks are regulated by Reserve Bank of India (RBI). So there are some differences between the home loans given by  HFC and banks. Interest on Home loans granted by HFCs are fixed on the basis of the an internal rate popularly known as Primary Lending Rate (PLR)  which is also sometimes known as Benchmarked Prime Lending Rate (BPLR.) It  is supposed to be the maximum rate which an HFC can charge to its customer. The actual rate may be at  PLR itself or even as a discount to the PLR.  A borrower with a very good track record will get higher discount as compared to an average customer on the home loan interest rate.

Since no customer is in a position to ascertain whether he has got the best deal or not as he does not know the bottom rate charged by the HFC to its best customer. This system of charging interest is not transparent and thus leaves scope for manipulation in  the actual rate charged to a particular customer.

Earlier the home loans granted by banks were also benchmarked against their PLR. However the RBI mandated in July 2010 to introduce a rate which is known as Base rate, a rate which is bare minimum below which banks are not allowed to lend except to it employees.  So the rate of  interest for home loans granted after 2010 is certain point higher than the base rate. The difference between the base rate and the actual rate charged to you is known as spread in banking parlance.

Under the Base Rate system a borrower knows for sure as to what premium he is paying over the best customer. So the lending by the banks under base rate is more transparent as compared to housing finance companies.

With the changes in Repo Rate by RBI, the borrowing cost of the banks also changes and thus the revision in Base Rate is more frequent as compared to changes in the BPLR.  As per the RBI guidelines banks were required to revise their base rate at least once in a quarter,  so the home loan rates were quickly aligned with the prevalent interest rate in case of home loan from a bank than a HFC as there is no such requirement to revise the BPLR/PLR so frequently.

During reducing Repo Rate era the transmission of reduction in interest rate was not as quick as the RBI expected it to be because the basis of calculation of Base Rate for each bank was opaque and was subject to manipulation.  Base rate would take into account the weighted cost of borrowing of different tenure and any reduction in Repo Rate prospectively actually did not reduce the overall cost of borrowing of the banks. In order to meet the problem of slow transmission of changes in Repo Rate, the RBI has introduced a new regime of Marginal cost of Fund Based lending Rate( MCLR) w.e.f. 1^st April 2016, under which the banks are now required to calculate marginal cost of fund to arrive at their lending rates.

Since MCLR is based on the marginal cost of funds as against the overall weighted cost of borrowings, the rate transmission is happening quicker. Under the MCLR home loan rates are re set with a time gap of one year. The RBI is also contemplating introducing a market determined independent benchmark for banks for determining their lending rates.  So as far as changes in interest rates is concerned, it is better to take a home loan from banks as the transmission in interest rate would be quicker than loan taken from HFC.

Prepayment penalty on your loan

Majority of the home loan borrowers either prepay their housing loan fully before its prefixed tenure or get their home loan transferred to another lender.  In both of the situations the existing lender used to charge you prepayment penalty. Over the period the rules for prepayment penalty have undergone changes. Presently the norms for prepayment penalty are different for HFC and banks.  In case of housing finance companies if you prepay floating rate, home loan which was taken on fixed rate but is under floating rate tenure, the HFC cannot charge you any prepayment penalty for part payment  or full prepayment.

Even in case of fixed rate home loans, HFC can not levy prepayment penalty if you use your own sources for prepaying the home loan. As per NHB own source means any source including borrowing from friends and relative but other than transfer of the loan to another bank or HFC. So in case your are shifting your fixed  rate home loan a penalty of around 2% is levied on amount of prepayment by the HFC.

As per the RBI guidelines no prepayment penalty can be levied for floating home loans. However for fixed rate home loans, whether to charge prepayment penalty of not is left to the discretion of the banks so  policies of all the banks are  not uniform.

So in case you intend to prepay your home loan taken under fixed rate regime, you better take home loan from HFC as you have liberty to prepay the home loan any time without incurring any penal costs.

Other Considerations

The decision  from who to take home loan will also depend on location of the property as the HFC/bank  may not be operating in those areas.  HFCs are more liberal in giving home loans to people who do not have adequate documents. So as far as the ease and availability of home loan is concerned, the HFCs are better option due to not so tight diligence as compared to one followed by the banks.