Article

Basics of the Base Rate
June 07 , 2012

The Indian entrepreneurial mind is sharp - you bring a law and people find loopholes in it and proceed to take advantage. Banks have been no exception. As home loan borrowers must have found to their chagrin in the past, there were two problems:

  1. Home loan rates (which are almost always floating rate nowadays) were jacked up when interest rates went up. But they were not reduced with the same speed when rates went down
  2. A bigger heartburn for old EMI payers was that new borrowers could get absurdly low 'teaser' interest rates for the first couple of years. From the third year, their rates were floating too. So of course, there was a big whammy at the end of the second; but who doesn't like to postpone a problem?

Effective 1 July 2010, the Reserve Bank forced Banks to address the first issue. They had to indicate a Base Rate, a minimum rate below which loans would not be given. They also had to indicate to a borrower how much above this would his loan cost. This 'spread' would remain constant, as the base rate changed (up or down) every quarter. This is a clean and efficient system.

Existing borrowers have the option of moving to this system from their old Benchmark Prime Lending Rate (BPLR) system. This old system was unfair and heavily biased towards banks. They could discriminate against borrowers and arbitrarily fix rates - there was really no 'benchmark' about it. Borrowers can move to the new system without charge.

If you have a floating rate loan under the old system, you should contact your bank and learn how much it works under the two systems. The moment the two seem similar, you should move to the Base Rate system. After all, this will hold you in much better shape if rates move down in future. Very likely, the arithmetic suggests you move immediately. Of course, the new system is less profitable for Banks, so don't expect them to invite you to it!

If, however, you were lucky enough to get hold of a fixed rate loan in the pre-2006 era, you might as well continue.

The Reserve Bank hasn't addressed the second issue - that of 'teaser rates' - yet. But we expect this to happen soon enough. In the meantime, if you have a house purchase coming up, you can get hold of the teaser rate before it is abolished. Of course, even in this case the party ends in two years and you get switched to the floating rate. So you should make sure your repayment capacity is adequate even for this much higher rate.

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