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Teaser Home Loan Rates - What you must know

Teaser home loan rates are back in the news with some banks and lenders now having extended these offers for another few weeks. What are these teaser rates? Are they good for you? Why is the RBI unhappy about them? And what should you keep in mind if considering such a loan? Here we answer all these questions for you.

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What are "teaser" home loans?

As the name suggests, teaser home loans "tease" you into action to seek a home loan. Lets understand why.

In order to stimulate demand from people looking to finance a house purchase, and also to take market share, teaser rates are being offered by numerous lenders at low introductory rates to tempt you into taking these loans. Typically, you can get a teaser rate starting at 8% - 8.5% for the first year, and then about 9% for the second year. Sometimes these rates are offered only for rates up to or below a certain size of loan (can range anywhere up to or below Rs 50 lakhs but depends upon the lender).

So for the first 2 years, you have clarity that will you enjoy a low home loan rate that is fixed at a pre-determined amount.

However, after this initial fixed rate period, by the 3rd year of the loan, the rate changes to a floating rate loan. Floating rate loans are loans where the rate of interest "floats" or is adjusted based upon the then prevailing rate of interest in the market.

Today you have no way of knowing what this floating rate could be. There is a likelihood that the rate can be much higher than the 8% introductory teaser rate you are paying at the start of the loan.

For the first 2 years, you have visibility on what your EMI payment is going to be because you know the interest rate that you will be charged. However, by the time the 3rd year begins, there is lesser certainty on what you EMI could be. There is always a chance that your EMI could be higher than what you can afford if the rate "floats" to a very high market rate of interest, based on then prevailing conditions.

Are teaser rates good or bad? Why is the RBI worried?

The RBI has expressed its concern on teaser rates and some lenders have even called them gimmicky. So are these loans good or bad for you?

Like all financial products, there are some aspects of these loans that are beneficial, and others that might catch you by surprise, especially if you are not familiar with how loans work.

The beneficial aspect of these loans clearly is that during the early tenure of the loan it makes loans more affordable than what they might have otherwise been, and offers families the opportunity to fulfill their dream of buying a home. Clearly, this is a good thing.

However, what the RBI is worried about is that the typical Indian family is not that financially sophisticated to understand at the time of loan disbursal what the rate might reset to at the start of year 3 of the loan. The concern is that lenders are tempting customers to get this loan without adequately educating them of what their EMI could be when the rate shifts from the low introductory rates to a higher floating rate. The RBI does not want to see families struggling to pay this higher EMI.

What should I do - give me some tips

If you are in the market for a home loan, or are already in the middle of applying for a teaser loan while these offers are still available, please keep the following tips in mind.

1. Ask your lender for the average loan rate across the life of the loan: Home loans are offered for a long tenure of more than a decade. While the introductory rates might be tempting, the rate might not be that low for the bulk of the life of the loan. So, ask your lender to give you an estimate, with a demonstration on a spreadsheet, of what your loan rate might on average across the life of the loan. What you should be aiming for is a cheap rate across the life of your loan, and not just for the first two years.


2. Understand the concept of Base Rate: Under new guidelines, all banks will be required to price their loans according to a Base Rate regime starting July 1. So, once the 3rd year of your loan begins, it will float according to the Base Rate of the bank. Ask your bank to explain this concept to you, because this will be the benchmark according to which your home loan will reset to at the end of the initial 2 years.


3. Understand that your EMI will increase in year 3: At the time of loan disbursal, you have the certainty of knowing what your EMI might be for the next 2 years. However, your loan is likely to remain outstanding for at least up to a decade. Are you confident that your income will continue to rise to be able to meet a higher EMI payment when the loan resets to a higher floating rate in year 3? Ask your lender to show you what your EMI could be and then analyze if this amount still fits into your budget.


4. Understand the pre-payment penalty for balance transfer: The last thing the lender wants is for clients to take advantage of the low introductory rates and then to see clients leave them when the loan resets to a higher rate. So, they make it harder for borrowers to leave the loan by charging very high pre-payment fees, or making it difficult for you to transfer your balance to another lender unless a certain minimum time period has passed. Understand how flexible your lender is going to be and what terms and conditions might bind you to your loan.

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