Bank rates, reset clause and the impact on the consumer

Every time you hear the news about an interest rate cut you would heave a sigh of relief thinking that the next EMI would be less than the current month's. However, the truth is most banks do not immediately pass on the benefits of the interest rate cuts to its existing customers.

So your next month's EMI will be the same and will not change probably until the beginning of the next quarter. At the end of the day you will be wondering why and how your bank has not passed on the interest rate cut on your home loan yet, or fear what repercussions it might have on your budget and about the best option available to you to minimize the impact.

Read on to find out the truth about how change in interest rates work and why a change in rate cut doesn't always mean an immediate lower EMI.

How change in interest rates work

The trend of offering lower interest rate on home loans is not a secret, at least in India. Whenever there is a shortfall in selling home loans or during festive seasons, banks line up to announce home loans at cheaper rate of interest. The idea is to attract maximum new customers at a lower rate of interest.

The new customers will definitely stand to benefit here but at a floating rate of interest the cheap offer just means an increase in interest rate is only round the corner probably till the period mentioned in the 'reset' clause on your agreement. This 'reset' clause is the same reason why the same rate cut for new customers has not been applied to you, an existing customer. So what is this 'reset' clause all about?

What is a 'reset' clause and how it could affect you!

Basically there are two aspects to consider when banks decide to hike or reduce their interest rates for its home loan customers. One, the exact percentage of interest rate cut or increase; and two, the reset clause.

A part of your loan agreement, the reset clause is the actual time period required by the bank from which the rate cuts or hike will be implemented. The rate reset clause could be monthly, quarterly, half-yearly or even yearly.

This means that if a rate cut is announced say sometime in March in the current year for a loan taken by you last November and your agreement mentions about a quarterly reset clause then the next reset dates will be applied only in November, February, May, and August.

Of course, this will vary according to the loan conditions. Hence, the benefit of the rate cut on interest announced in March will be reflected in your EMI only from the month of May and not in March. Moreover, the rate cut benefit will accrue on the principal outstanding from May and not March. For instance, if you have an outstanding loan amount of Rs 10 lakh say in March and Rs 9.50 lakh in May, the new interest rate will apply only on Rs 9.50 lakh.

But why a 'reset' clause is required at all?

The reset clause is required by the banks for ease of calculation and to maintain a confidence in the process. Consider the chaotic scenario where the interest rates on millions of rupees sanctioned in the form of loans are reset on any random day!

The banks will end up with the impossible task of calculating the interest every single day on different loan amounts which could equally affect the borrower. The specific time mentioned in the reset clause to adjust the change in interest rates at regular intervals will help the lender and the borrower ensure an orderly calculation, disbursement, payment and collection.

What can you do to minimize the impact?

Unfortunately, there is not much you could do as a borrower as far as the rate cuts are concerned. In most cases, your loan agreement will not allow you to negotiate on the rate cuts. Also, the banks do not engage in negotiation with the borrowers on this point as their specific products have a specific reset clause.

Probably the one best thing for you to do is negotiate with your bank to reset the clause to every quarter if your agreement has mentioned about a half yearly or in worse cases an annual reset clause. This way you can save the money paid on interest rate.

Courtesy: BankBazaar.com, Rediff

All About Registration --> the process and the cost to customer

Not many people are sure about the registration process and how much it would cost to the customer. Hence, I thought of writing this post. In this post, I would try to cover all the expenses related to the registration process and explain each of them with some numbers. The below process holds good if you are planning to buy an indepdendent house/villa.

Registration (Stamp Duty): Goverment assigns a value to the land involved in the project. Let us assume that the value of land as per govt. standards is 6000 INR per sq. yard. Now, stamp duty is 9.5 % of the value.

If you chose a 200 yard sq. yard plot, you have to pay 9.5% of 200*6000.

VAT: VAT varies as per constructed area which will typically be in sq. feet. This also depends on the agreement of concession. VAT is 1% of the agreement of concession.

If the value per SFT is 2000 as per the agreement, a 2500 sq. ft of constructed area would attract a VAT of 2500*2000*1%

Service tax: Service tax 4.08% of the agreement of concession.

The above three components cover the complete registration cost (in the case of independent house).

On Growth Path... again

With the global economy showing signs of recovery and with stable government at the centre, India seems to have re-started its journey on the path of growth. The recent address by the nation’s president Dr. Pratibha Patil has references to give impetus to the Commercial Vehicle segment, pension reforms, skill development and not to forget, the most relevant of all, the housing sector.

At the outset, it looks like, the government is planning to make credit available to builders (increase liquidity in the credit markets) and housing loans available to customers who were earlier deprived of housing loans. These consumers are not necessarily sub-prime.

A recent show in CNBC (Hindi channel) showed that around 3500 houses were sold in Mumbai in the last two months. That is a clear indication of the positive trend in the market. Developers like the JP group, HDIL confirmed the positive movement in the market. All this coupled with burgeoning urban population has the potential to spur the economy. Many developers conform that they may not see the mad rush for homes as during the 2005-2008, however most in the industry see an increase in the traction in the market.

What this means for the costumer: With easy availability of credit to developers, they can see more apartments being built, more choice, more competition and more value add to the customer.

From the developers’ side, one should not forget that the market is not friendly to everybody and always. If one company takes a wrong call (could be investing heavily at sky high prices during very high valuations), one such wrong call has the potential to shut its operations. As they say, the fittest will survive post any tough time.

Urbanization and its importance in the context of India

I attended a course on Manufacturing Wealth: The Economics of Urbanization by Dr. Atanu Dey while I was doing my MBA at ISB. As interesting as his class is, his blog is equally engaging and gives a lot of useful information and perspectives to the reader. I thought it is beneficial to the readers of this blog to introduce them to Atanu’s blog.

His blog address is http://www.deeshaa.org/

For people who want to know more about the relevance of urbanization and the role of urbanization in the context of India, Atanu has written some very good blogs in the cities-and-urbanization category.

The blogs can be found here: http://www.deeshaa.org/category/cities-and-urbanization/

For people who to know more about how cities can spur the growth of our country, I would urge them to go through the posts on “Imagining Indian Cities”, “Urbanization and Development of India”, “India Cannot Afford Villages”, “India Needs Cities”.

Happy reading readers and thanks to Atanu for such wonderful posts.

To Do list while purchasing an apartment

1)      1) Verify the link documents of the land in which the apartment is built. 

Link documents: They state the legal implications associated with the property. Link documents are documents issued by revenue dept for a particular land or survey numbers at regular intervals revealing the information of buyer seller within that period. These docuuments are called Pahanis in real-estate jargon. The documents constitute all the sale deeds exchanged between the previous property holders.

Generally, development of housing projects is carried over in two formats.

a)      The real estate developer takes the land “on development” basis. The land owner is given a stake in the venture. This is similar to equity stake owned by investors in a project. If the property you are interested in is taken on “development” basis, it is suggestible to verify the agreement between the developing company and the land owner.

b)      If the firm that is selling the apartment owns the land on which the apartment is built, you can check the land ownership documents, link documents pertaining to the land.  (same as point 1). 

2)      2) Check the government approved layout plan, building plan, ownership documents.

3)        3) Also, verify the bank approvals for the project to avail home loan facility. Generally, banks approve projects and issue loans against only approved projects.

4)          4)  It is suggestible to verify the history/reputation of the builder.  You can look up previous projects carried over by the builder or just talk to people who bought apartment from the builder.

By doing all the above 4 steps carefully, you can be a happy home owner. One can also contact an advocate to do the same thing.

NRI's: Investing in Real Estate .. is this the right time

With the rupee touching 50 for each dollar and real estate prices touching bottom levels, the current real estate markets offers a very good investment opportunity. Especially for NRI’s interested in buying property in India, this is an excellent time. You can think of waiting for some more time, but it is very unlikely that the prices will go below the current levels; primarily due to the fact that the current prices offer not much margin for the real estate developers to offer discounts.

Let me do some math to show the rationale behind the above logic.

Let us consider an investment of INR 40 Lacs in an apartment. Investment made at the time of March 2008 would cost approximately USD 100 K (one hundred grand US dollars). We all know that there is a correction in the prices of the real estate sector from the March 2008 levels. I am going ahead with the assumption that prices declined by 15 %. So, a property worth INR 40 Lacs would be available for INR 34 Lacs (40*(1-0.15)). To account for the devaluation of rupee (you can call it appreciation of US dollar), I am using a conversion factor of INR 50 for a US dollar. Now, the same property would be worth USD 68 K (sixty eight thousand US dollars). Now, that's a real discount of USD 32 K.

The above numbers vary significantly if you play around with the assumptions I made. However, you will notice that the above assumptions are very conservative. We all know that the real estate prices have gone down by more than 15%. I just used 15% to show how the numbers look even with a very conservative estimate. You can do the math by following the above steps and by using the closest numbers to see how much of real discount you get by investing in property now.

Now, let me focus on why one should not wait longer. Most of the property dealers brought land at sky high prices. They have already made investments in the land and they went ahead with the projects. They priced the projects accordingly with a good margin. By good, I mean around 20 to 25 % margins. With the current decline in market prices, the margins a real estate developer makes on his project are under severe pressure. It is very unlikely that the prices of apartment s or villas will come down mainly due to the fact that most of the land used for developing these projects was brought at sky high prices as explained above. One can expect a decline in prices for the projects that will get started on the land acquired now. However, there is not much land acquisition going on now (at least what I know of). Even if somebody had purchased land, nobody wants to start projects during these tough times. So, everybody is delaying projects for good days. If the market picks up in the next one year, then you know how fast prices would go up. Or, if the dollar depreciates (or rupee appreciates… we all know Indian economy is not in such bad shape and has the potential to maintain a solid 6% growth rate), this opportunity will be missed.

So, give it a thought. If you are interested in talking to us, click here.