What is PLR and how does it impact home loan interest rates?

PLR stands for prime lending rate. It is the benchmark rate of interest at which banks lend to borrowers. When the Reserve Bank of India (RBI) takes measures to control inflation or liquidity, many public and private sector banks react by raising their benchmark lending rate. This makes home, personal and vehicle loans costlier, dampening credit demand.

Why go for floating rates in these conditions?

To float or get anchored is a vital dilemma for many borrowers at this juncture. Experts point out that rates at this juncture are still high and may drop further down. Since fixed rates are a few points higher than the prevailing floating rates, it makes no sense to get anchored.

When will existing borrowers benefit?

Only a few banks have reduced the interest rates for existing borrowers. In order to entice new borrowers in this dampened climate, low rates are offered to them. So for now, existing borrowers have to wait for rates to fall substantially before the benefit reaches them. Borrowers unhappy with their lenders can consider refinancing with another lender offering better rates.

The realty sector has been one of the worst hit sectors in the recent past due to variety of reasons. The bad times for the realty sector commenced with rising cement and steel prices, coupled with the Reserve Bank of India raising the interest rates to combat rising inflation. Thereafter, the global financial crisis brought with it an economic slowdown. All of these reasons resulted in a quick slump in demand for residential and commercial properties.

During the last year a lot of realty firms had raised money from the capital markets and through private equity with RBI policies making it tough for the realty firms to raise bank finance. However, these alternative funding sources have dried up since the global financial crisis broke out. Realty firms finding themselves at the receiving end of the bloodbath on Dalal Street made matters worse for the realty sector.

These things clearly signaled a serious crisis for the sector which resulted in the industry leaders in the sector requesting for a Government intervention. The realty firms expected the Government to take steps to bring in more liquidity into the sector by easing lending norms and also requested for a reduction in housing loan interest rates to boost the demand.

The RBI provided a breather for the sector last weekend by announcing a slew of measures especially for the real estate sector apart from 100 basis points cut in the interest rates. One of the most important announcements includes Rs 4,000 crore refinance facility for National Housing Bank. The RBI has also decided to grant "priority" status for housing loans upto Rs 20 lakh and for loans given by banks to housing finance companies for on-lending to individuals for purchase or construction of homes of upto Rs 20 lakh.

As per the existing RBI norms, every bank is required to set aside 40 percent of its deposits for lending in the priority sector. As a part of the policy announcements on Saturday, the RBI has also clarified that banks can classify housing loans up to Rs. 20 lakh as "priority sector" advances, subject to a ceiling of five per cent of their total priority sector limit. The above moves are expected to provide a life line to the realty firms who operate in the low-cost housing segment. This measure would also help the housing sector and the realty firms which operate in the nonmetros or the Tier II cities.

The other major measure announced by the RBI on Saturday has been the relaxation of asset classification norms for commercial real estate advances. It may be recalled that the RBI had, earlier this year, issued a directive requiring the banks to classify advances to a property developer as a Non Performing Asset (NPA) the moment the advance was restructured. This directive of the RBI had made raising bank finances difficult for developers whose loans were classified as NPA by other banks.

The RBI has now relaxed the asset classification norms for commercial real estate advances, by granting concessional treatment to commercial real estate advances which are restructured upto June 30, 2009. This one time measure grants a relaxed treatment of non-classification as NPAs to second restructuring done by banks of real estate advances before June 30, 2009. This step would surely relieve the realty firms of the liquidity crisis. This move would also encourage the banks to increase their exposure to real estate sector. The 100 basis point rate cut should also ease the cash crunch situation if the banks lower their lending rates.

Though some of the realtors have voiced their opinions on the measures announced by RBI not being sufficient, these measures are intended to boost the demand for low-cost housing and also ease the cash crunch situation which the realtors are facing. These measures together with the Rs 30,700-crore fiscal stimulus package unveiled by the Government aimed at guiding the economy away from a possible downturn.

Currently, the economy is going through a slowdown across the board. Due to the slowdown, the prices of property went through a correction. Many experts believe this is the right time to invest in property. Interest rates on home loans have also come down in the last few weeks after the Reserve Bank of India (RBI) cut the policy rates (repo rate, reverse repo rate and cash reserve ratio) drastically during the last four months.

Analysis of condition of economy

Currently, the economic conditions are not good across the world. Many developed countries are in a much worse situation as they have a dip in their real GDP during the last couple of quarters. For example, US, UK, Germany and Japan are already in recession. India is in a better condition.

In India, the economic growth rate has come down from nine percent last year to less than seven percent this year. Analysts and experts are predicting that the bottom of recession has not yet been reached and we may see a further dip in this growth number in the months to come.

Analysis of home loan rates

Home loan interest rates peaked during the middle of last year. They started coming down after the RBI cut the policy rates drastically in the last four months.

Here are some reasons why home loan interest rates are expected to come down in the short to medium term:

Some banks have not yet passed on the full benefits of previous rate cuts to their borrowers. They are taking a cautious approach towards reducing the loan rates and fresh loan disbursals.
The inflation rate has already come under control due to lower commodity prices in the global market The government will pressurise banks to reduce the interest rates on home loans

• For those borrowing now

Looking at the current scenario and expectations of the near term, it is clear that home loan interest rates are not going to go up. It will have a tendency to go down in the near future. Therefore, it is recommended to go in for a floating interest rate home loan scheme. The banks have not reduced rates substantially on fixed interest rate home loan products. Thus, fixed interest home loans come at significantly higher interest rates than floating interest rate loans.

However, it is good to look for banks which provide the option to switch from floating rate loans to fixed rate loans by charging a small fee. Other factors that borrowers should look at include pre-closure or pre-payment penalty, processing fee etc.

• For those who have already borrowed

Some banks have not yet revised the interest rates downwards for existing borrowers in some cases. Such borrowers can consider a switch option. However, they should weigh the cost of the switchover with respect to interest rate differential before making such a decision. The cost of the switch includes pre-closure penalty, processing fee of new loan, registration charges etc.

Many banks provide software that calculates the exact difference in terms of total cost between the old loan and new loan. You can analyse the comparison and look for loans with faster recovery of switchover costs by way of savings from the interest component of EMIs payable under the new loan.

A further drop in home loan interest rates is expected as the inflation rate is under control now

Many are facing is facing a dilemma and they have identified a lavish apartment in the heart of the city. The developer has promised him a bargain deal. Before he approaches a lender, Narsimha has to decide between floating and fixed rates. The unpredictable rate movements, the Reserve Bank of India's (RBI) moves and mixed response from the lenders has put borrowers in some confusion. The inflation monster which had pushed prices to unimaginable highs has finally been tamed. From as high as 12.91 percent this year, the inflation rate has almost come down to half of that.

Does this mean borrowers can expect banks to reduce their home loan rates, if this trend persists? What is inflation?

Inflation is an increase in prices and/or decline in purchasing power. An increase in the amount of currency in circulation results in a relatively sharp and sudden fall in its value, and rise in prices. It can also be defined as a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. Inflation is caused more by global rather than by domestic factors today.

The year 2008 has seen extreme turbulence in all quarters. The stock markets tumbled down, wiping away tons of investor wealth. The inflation numbers touched new peaks and crude oil prices shot up. Prices of essential commodities and food rose sharply. And so did home loan rates, impacting borrowers adversely, especially those who did not see a proportionate increase in their pay purses.

High inflation rates are dealt with through a combination of market forces and government regulations. A host of RBI measures ensued. The RBI continuously monitors the monetary and liquidity conditions to maintain domestic macroeconomic and financial stability in the context of the global financial crisis. It hiked the repo rate and the cash reserve ratio (CRR), and then resorted to slashing them again.

The repo rate is the rate at which banks borrow money from the RBI. A reduction in the repo rate will help banks get money at a cheaper rate. When the repo rate is increased borrowing from the RBI becomes more expensive. The CRR is the proportion of reserves commercial banks must keep with the RBI. It has been slashed to 5.5 from nine percent. With the inflation rate declining, the RBI is expected to announce a further reduction in the repo and reverse repo rates.

Lending rates had gone up after the RBI took measures to tighten the money supply in a bid to bring down inflation. With inflation well under check, can borrowers expect a further fall in rates? Most public sector banks had lowered rates making it affordable. Some banks are yet to offer the reduced rates to their existing customers. In such a scenario, a floating rate loan would be an ideal choice. Since there is a possibility of reduction in rates, floating in these turbulent times is better than being locked at a high rate. Those who are unsure can wait for the turbulence in the markets to quell.

Real estate has been an ideal hedge against inflation over a long term. Limited land resources, a growing economy and increasing population make real estate an ideal investment avenue. When demand for housing goes up compared to supply, prices shoot upwards. With a fall in rates on the horizon and lucrative bargain deals offered by developers, it is time you seriously explored owing a house.