Bank Home Loan Vs NBFC Home Loan: Predictable EMIs Matters More Than You Think

Housing finance companies (HFCs) and non-banking financial companies (NBFCs) have been one of the fast-growing sources of home financing. As banks often do not extend loans to borrowers with irregular incomes, NBFCs have stepped up their housing finance funding, assessing borrowers based on the cash flows, and using different underwriting methods to assess the value of the property and the credit worthiness of the home buyer.

That has led to NBFCs going the extra mile to fund higher loan values. Again, a lender has to be willing to consider the borrower's income, review the property, sanction the loan amount and design a structure that the customer can afford to pay back over 15-20 years.

Hence, for many homebuyers the choice of taking a home loan does not rest on the rate of interest alone. The convenience and flexibility NBFCs offer in terms of financing has seen many homebuyers turn to them for funding their dream home.

NBFCs have made themselves relevant in the home loan space, particularly for small borrowers, business owners, self-employed whose income or asset profile may need to be seen through a different underwriting lens.

The Difference

There is a key difference between an NBFC home loan and a bank home loan, and that is the way in which the lender itself raises money.

Banks have access to current and savings accounts and retail term deposits, which constitute a pool of funds whose cost tends to vary marginally as the deposits reprice and change slowly. Much of the funding is through savings accounts where interest rates barely move fast.

However, HFCs and NBFCs do not have the same funding structure as banks. They have recourse to bank borrowings, bonds, debentures, commercial paper and other market instruments to raise money, and their cost is often influenced by liquidity and financial markets conditions.

As the RBI considers a regulatory framework designed around the way in which a bank’s cost funds will be taken into account, the customer of the NBFC is the one who could feel the impact.

Why Should The Borrower Bear That Difference?

Imagine two families with similar incomes, credit scores and floating rate home loans of Rs 50 lakh. One borrowed from a bank, while the other opted for an HFC because its underwriting, loan eligibility or service was more convenient for the family.

Nothing has changed in either family’s financial situation. They continue to pay their equated monthly instalment (EMIs) on time. Now imagine that wholesale financial market rates rise sharply for a relatively short period.

The HFC may experience a higher cost in raising fresh money because its funding model is more vulnerable to taking money from the market. Should its existing home loan customer necessarily experience more interest rate volatility just because the family chose an HFC?

That is the consumer question raised by the proposed framework. A borrower who has chosen an HFC for legitimate reasons should not be penalised just because the institution that funds the loan uses a different liability structure.

A Home Loan Is Not A Money-Market Product

There is also a mismatch in time horizons. An HFC may raise funds at different maturities and at various points in the interest-rate cycle. The home loan that it provides could last for 20 years. The lender’s funding book does not shift immediately to today’s market rate because the cost of fresh borrowing has increased. This has a bearing on the choice of the benchmark for a floating-rate home loan.

The proposed framework by the Reserve Bank of India (RBI) allows an NBFC flexibility in choosing the benchmark and also permits a derivation of an internal benchmark from the marginal cost of funds under a documented methodology.

What Could It Mean For Your EMI?

Consider a Rs 50 lakh home loan with 20 years to go. At a rate of interest of 8 per cent, the EMI is around Rs 41,800. At 9 per cent, it goes up to roughly Rs 45,000 if the original tenure is retained. That is an increase in more than Rs 3,000 every month.

Alternatively, the lender could keep the EMI the same and extend the loan tenure to increase the amount of interest that the borrower will eventually pay.

Floating-rate borrowers must obviously accept that rates can rise as well as fall, but there is a difference between transmitting a genuine change in the long-term cost of money and transmitting every temporary fluctuation in wholesale funding markets.

The objective is not to prevent floating rates from floating, but to ensure that a long-term housing loan does not behave like a short-term financial instrument.

An HFC or NBFC may add value in other ways: specialised underwriting, assessment of self-employed or variable-income customers, familiarity with particular housing segments, loan eligibility or service.

The value of that lending model should not be undermined by exposing its customers to unwanted short-term rate volatility because the lender funds itself differently.

Different Lenders, Same Need For Predictability

India needs different kinds of housing lenders because Indian borrowers are also different. A salaried employee, a doctor running a clinic, a shopowner and a first-generation entrepreneur may have similar repayment capacity, but different income patterns.

Banks, HFCs and NBFCs can, therefore, play complementary roles in financing home ownership. A rate-setting framework should preserve that choice without creating an unintended penalty for a customer who chooses a specialised lender.