What the SBI rate cut means for borrowers

If you are planning to buy a home or a car anytime after 7 August , there is good news. India’s largest bank, State Bank of India (SBI) has decided to cut interest rates on home and auto loans from 7 August. The bank has decided to cut the rates on home loans by 25 basis points while the auto loan rate has been slashed by 50 basis points. So, for home loans up to Rs 30 lakh you will have to shell out an interest rate of 10.25% per annum (p.a) as compared to the prior 10.50% p.a. While the rate on car loans is now 10.75% p.a. as compared to the prevailing 11.25% p.a.

What’s the issue: While this may come as good news for new borrowers, existing borrowers stand on the downside of advantage. The new rates are applicable only for new borrowers and the existing borrowers will continue to pay the higher rates. The Reserve Bank of India had done away with the prior Benchmark Prime Lending System and replaced it with transparent base rate system in July of 2010 to avoid such discrimination against existing borrowers.  Says, Harsh Roongta, CEO, Apnapaisa.com, “This move by the largest and most respected bank of the country (which is also a public sector bank that is supposed to follow rules not only in the letter but also in spirit) is a mockery of the principal of transparency that the base rate regime was supposed to usher in. The regulator had introduced this system as a transparent system as compared to earlier BPLR system.” What has the bank done: Any loan is made of two broad components, the base rate (below which the bank cannot lend) plus the spread. The bank has kept the base rate unchanged, while they have made a variation on the spread for new borrowers. So, while the existing borrower will pay 10% (base rate) + 0.50% (spread) = 10.50%, the new borrowers will land up paying 10% (base rate) + 0.25% (spread) = 10.25%.  So a Rs 30 lakh home loan with a tenor of 20 years at rate of 10.50% will cost the existing borrower Rs7,188,335,  while for the same loan the new borrower will have to pay Rs.7,067,833, that is Rs1,20,502  less. Roongta says, “With this move the new borrowers will get a lower rate while the existing borrowers will continue to be on the higher rate. This does not give justice to the existing borrowers, since the bank has reduced the spread over the base rate only for the new borrowers.” What should you do: If you are an existing SBI borrower, you have two options. Adhil Shetty, CEO, Bankbazaar.com, online loan portal, says, “The existing customer has an option to either refinance with the same bank by paying a processing fee or look to switch the loan to another bank that offers a lower rate.” The best part is that just last year the apex bank had done away with pre-payment changes for home loans on floating rates, which mean, you won’t need to pay prepayment charges to refinance or switch the existing loan. Shetty says, “While switching to a new bank, do consider the total cost of switching, that is the processing fees. Also keep in mind that refinance and switching will need some efforts from your side for follow up.” Whether base rate system has failed to live up to its claimed transparent image is a larger issue which RBI has to look into. As far as new borrowers go, making the most of the rate cuts makes sense. As far as existing SBI borrowers go, getting over the inertia and looking to refinancing or switching the loan for a better deal makes sense. If you are an existing borrower with another bank, you could look into switching to SBI, but only after taking the total cost of switching into account.