Why cheap homes loans might not be the best

It is not being argued that SBI is doing a bad thing by announcing low rates, but it is necessary for you to understand the full implications of such loans before taking one, says iTrust Financial Advisors.

Last week, the State Bank of India announced a further reduction in its home loan rates across different amounts of loans. This new scheme looks very tempting, but there could be more to it than meets the eye.

While this might be beneficial to families aspiring to buy homes, we would caution borrowers to understand all aspects of cheap home loan rate schemes from different banks and the process associated with it.

The facts: How do cheap home loan rates work?

SBI has offered teaser rates for the first 3 years, depending upon the size of the loan, below Rs 5 lakh (Rs 500,000) or above. During this period, the rate adjusts to a higher amount by about 0.5%.

Then around the year 4 mark of the loan, the loan gets further adjusted depending upon the then prevailing in-house rate of interest that the bank prices all other loans at.

For example, for loans between Rs 5 lakh and Rs 50 lakh (Rs 5 million), SBI will charge 8% in year 1, and 8.5% in years 2 and 3. From year 4, the borrower can choose between a floating rate of 2.75% below the State Bank Average Rate (SBAR) and a fixed rate of 1.25% below SBAR.

There is no way of knowing today what SBAR is going to be a few years from now, because this rate is set internally by the bank.

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But, aren't cheaper rates good for me?

Sure, cheaper rates are good because they result in lower EMI (equated monthly instalments) payments. However, this is not all because, over time, these rates re-adjust upwards and could result in higher EMIs.

Experience has show, particularly during the sub-prime crisis in the United States, that those who took low teaser rates to buy homes, tempted by cheap rates were often the ones who ended up in financial trouble a few years later.

This is because when the rates adjusted upwards, they did not have sufficient income to pay the higher EMI.

We are not arguing that SBI is doing a bad thing by announcing low rates and that their actions will result in a crisis.

We are just cautioning that these rates should not be as tempting as they appear. And here are some reasons why. . .

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Understand long-term implications

Home loans are long-term borrowings, often with a tenure of up to 10-20 years. So what you should really be thinking about is if you going to be better off in the long-term or not and not just in the first year.

Can you afford all the payments during the entire duration of the loan? Other banks might be offering you a home loan rate where the average rate across the tenure of the loan might be as cheap.

Do you understand what the Prime Lending Rate (PLR) is?

Every bank has an internal interest rate according which all other loan rates are priced. The bank has full discretion to set this rate. Ask your lender to explain to you how the bank's PLR might fluctuate and how these changes might affect you.

Penalty for balance transfer

When you get a loan with a low rate, your flexibility is likely to be restricted. This can hurt you if and when you need to re-finance your loan with another lender that might offer your better terms in the future.

Understand if there will be a penalty for a balance transfer and whether you will be allowed to transfer your balance at all. Could the penalty fee be so high that it offsets any benefit of taking a home loan with a cheap teaser rate? Understand how flexible your lender is going to be.

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Processing headaches and customer service

Most critically, understand what kind of customer service you can expect from your lender. We have seen enough clients go for cheap teaser rates from banks, only to suffer because either the file is not processed on time or the disbursement is delayed.

Don't fall for a low rate if you have even the slightest of doubt that your loan process will take time. It is not worth putting yourself through the emotional stress that we have seen our clients go through when dealing with some of these lenders.

So, don't just blindly go in for these cheap loans without understanding the full implications of what you are signing up for.

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