Personal Finance Articles

Hidden Clauses in a home loan agreement

Except for the recent rate hikes, the buoyant mood in the home loan industry seems to last forever. Various incentives such as waived processing fees and added incentives in the form of free insurance policies, credit cards etc. in the home loans industry have proven to be a bonanza for consumers. From the loan seekers’ point of view three factors i.e. interest rates, tenure and the EMI (Equated Monthly Installment) are considered to be of utmost importance. Once the loan seeker is comfortable with these areas, the process is set into motion. What’s more, with a number of lenders on offer, taking a home loan has never been easier! But, almost as if a cartel is operating behind the scenes, the terms and conditions behind the home loan are framed in such a manner that the HFC acquires a strong legal backing and hence you are left on the backfoot. Moreover, in the euphoria to acquire that dream house, various clauses in the loan agreement are often overlooked. After all, the loan document runs into 50 pages and its legal language is so esoteric that it does not even look like English. So you think, “If everyone signs the same agreement with the bank, what is there to read?” If this sounds like you, think again! There are a whole lot of potential minefields in all the leading banks’ home loan agreements. These clauses have a significant bearing on areas ranging from interest rates to repayment schedules. Infact, simple clauses pertaining to how often the housing finance company (HFC) resets interest rates in a year can make a considerable impact on floating rate loans. Some of the important areas you need to watch out for are:

a)“Spread” - Spread is the difference between the PLR and the home loan interest rate. When you opt for a floating rate, you may be assuming that you will pay less when interest rates fall. But your floating rate is not really benchmarked to current home loan interest rates, it is linked to the “spread”. And this spread does not always change every time interest rates fall. Let’s take the example of few leading banks. In the case of HDFC, the PLR came down from 11.5% in January 2002 to 9.75% in July 2003. It increased to 10.25% in November 2004. HDFC officials say that spreads during this period increased from 1% to around 3%. So for someone who took a floating rate loan in July 2003 at a spread of 1% to PLR, his effective interest rate would have been 8.75%. But someone who took a loan say in July 2004, may have got a spread of 2% and hence paid only 7.75% interest. While most bankers say that the benefit of floating rate is passed on to all customers, what they don’t tell you is that this benefit is passed on disproportionately.

b) Fixed loan reset clause: Many a time people who have taken a home loan at a fixed rate receive a shock when they receive a letter saying it is time for renewal of his loan and that their interest has been increased by x per cent. On checking with the bank they are informed that there was a reset clause in their fixed rate home loan agreement that allows them to change the interest rate in the future, even on fixed rate loans. For instance, while SBI has a clause wherein it has the right to revise the fixed rate after two years, Corporation Bank and Canara Bank have reset options at the end of five years. Clearly, most borrowers are misled by the ‘fixed rate’ loan. Hence, read the loan agreement carefully, look out for the reset clause and quiz your HFC about it.

c) Defining defaults - HFCs go way beyond non-payment of loan installments when it comes to defining defaults. For instance, Citibank’s home loan agreement defines a default as—(i) “where the borrower, or where the loan has been provided to more than one borrower, any of the borrowers is divorced or dies (applicable in case of an individual)”, and (ii) “if the borrower or any of the borrowers is/are involved in any civil litigation or criminal offence.” While many of these conditions are against citizens constitutional rights the borrower has to abide by the conditions set down by the HFC. Hence, it is best to understand these conditions before signing up for the loan.

d) Force Majeure Clause - A semi-fixed rate loan often gets advertised as fixed rate loan. The true picture comes to light only if the you read the clause which says, “Provided further that from time to time, the bank may in its sole discretion alter the rate of interest suitably and prospectively on account of change in the internal policies or if unforeseen or extraordinary changes in the money market conditions take place during the period of the agreement.” This is called a force majeure clause, which allows a HFC to ‘un-fix’ and raise the rate under exceptional circumstances.

d) EMI default - Lending HFCs’ legal remedy for defaults on loans having outstanding amount of Rs 10 lakh and above, is to file a suit against the borrower under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. For lower amounts they can file a suit in the civil court. The attitude however varies from bank to bank; foreign banks being extremely aggressive in comparison to private banks and public sector banks. Infact, some banks send threatening agents to your home to recover the loan. While, direct snatching is not approved by any law and in fact violates multiple provisions of the Indian Penal Code, many HFCs adhere to such practices. You need to be wary of taking loans from such HFCs.

e) Security cover during falling prices - When property prices crash you may be asked to provide security over and above the home mortgage; the bank considering you to be a defaulter if you don’t give the additional security. The clause that enables this reads: ‘the bank may declare all sums outstanding under the home loan (including the principal, interest, charges, expenses) to become due and payable forthwith if the value of the property or any security (including guarantees) created or tendered by the borrower, in the sole discretion and decision of the bank, depreciates entitling the bank to call for further security and the borrower fails to give additional security.’

f)Direct disbursement to builder - A clause in many home loan agreements stipulates that the “disbursement of the loan may be made directly to the builder or developer and in the case of a ready-built property to the vendor thereof and/or in such other manner as may be decided solely by bank.” Considering that it is your original property papers are retained with the bank, so ideally the bank should disburse the loan amount to the you and not to the builder. Such a clause gives too much power to the bank and one should be wary.

g) Assignment to third parties - HFCs take your authorisation to assign collection and administration rights on your loan to third parties. The clause which states this action is: “Borrower expressly accepts that the bank shall be entitled to appoint third parties as the bank may select which gives to such third party all or any of its functions, rights and powers under this agreement including the authority to collect minimum monthly repayment due by the borrower.” Elsewhere, this agreement further states, “the bank may assign any of its rights or obligations herein without any approval or consent of the borrower.” This is clearly an unfair provision because you look at a bank’s reputation and credibility before entering into a loan agreement with it. Unfortunately, no HFC offers you to exit the agreement if this happens.

h) Vague clauses: There are many ambiguously worded clauses in a home loan agreement.
a) Take the clause, ‘The bank/HFC will be notified of any change in the borrower’s employment, business or profession well in advance.’ The terms ‘well in advance’ is very vague and not specified by the bank.
b) In your early EMIs, the proportion of interest charge is far higher than principal repayment. Check the calculations in your case.
c) Pre-loan procedure - For document processing, banks charge around one per cent of the loan amount which should be refunded if the banks ultimately deny the loan. This is not explicitly mentioned in most cases.
d) The legal jurisdiction in case of disputes is always at the place where the HFC’s central office is located. Individual borrowers, who are spread across the country, cannot afford to travel long-distance to seek legal enforceability of their rights.
e) Cross default is another faulty clause where the HFC deems you a defaulter on your home loan if you have made any kind of default in any other loan or facility with the same HFC. Ideally, these are two different transactions and each one’s performance or non-performance should be measured independently.
f) The amendment clause – Consider the following clause from a home loan agreement: “The bank shall at its sole discretion alter the terms of this agreement by written intimation sent to the borrower by courier. Any amendment proposed by the borrower shall be valid only if made by a written agreement signed by both the parties.” Given this clause you are in a loosing position from the very beginning.

Take-home – If you are hunting for a housing loan, you are certain to try and get the best deal on interest rate. However, you might be careless about the fine print within the loan agreement. The excitement of having closed a housing loan deal may result in you skipping certain clauses which can be a cause of immense concern. Asking for what is fair and due to you is not that difficult. Make sure that that you bring these lopsided clauses to the notice of the HFC, suggest changes and bargain hard to get them implemented. If the HFCs persist, then go with a HFC with whom you agree with most of the conditions.


Ten questions to ask before taking home loan
1. Is it a fixed or a floating rate loan?
2. What is the floating rate pegged to?
3. How often is the peg changed?
4. Do I have a switch option?
5. Are there restrictions on pre-payment?
6. Is there a pre-payment penalty?
7. Is there a takeover charge?
8. What are the other charges that come with the home loan?
9. Can I get to read the loan agreement?

What if there is a problem - Incase of a problem once you have already signed up with a HFC then lodge a formal complaint with National Housing Bank (NHB), if your home loan is from a non-bank HFC.You can write in to NHB through its website www.nhb.org.in or nhbh01@bol.net.in . For banks, write in to RBI through its website www.rbi.org.in or helpprd@rbi.org.in .

Experiences from the west - In the west, the borrower is made more comfortable than the lender for all loan transactions. Here the laws are framed such that the position moves from 'let the buyer beware' and puts the onus on 'let the seller disclose’. This is because in countries like the US, the purpose of lending is viewed from the point of economic stabilization, which, it is said, is attained by informed use of credit by consumers. In the US Credit transactions are serious, transparent matters, which are monitored in unambiguous legal terms by way of Truth in Lending Act (TILA).

TILA requires that a full disclosure of the credit terms and other related costs be made available to the borrower in simple and easy-to-read language. This includes the amount and definitions of annual percentage rate, finance charges and other related terms. These disclosures must be clear and noticeable and must appear in a document that the consumer may keep. In addition to this, the Federal Reserve Board and the Federal Home Loan Bank Board have published a booklet titled 'Consumer Hand book on Adjustable Rate Mortgages'. The booklet is a guide for consumers to understand the uses of adjustable rate mortgage loans.

According to Regulation Z in the booklet, which applies to each individual or business that offers or extends consumer credit, the lender who is offering an adjustable rate mortgage loan must make this booklet or a similar one available to their borrowers. The Act also requires that before credit is extended, disclosures are made to borrowers. In certain cases, it must reflect in periodic billing statements. Regulation M, which includes all the rules for consumer leasing transactions, also details rules for disclosing terms when leasing personal property for personal, family or household purposes. In case of non-compliance with TILA, penalties are severe; a lender violating these disclosure agreements being sued for twice the amount of the finance charge .

Code of Conduct - National Housing Bank has framed guidelines on fair practices code for Housing Finance Companies (HFCs) to serve as a part of best corporate practices and to provide transparency. Some of them are mentioned here as these can empower you further in dealing with the HFCs and violations can be taken up legally.

· At the time of enrolling, HFCs shall provide information about the interest rates applicable, as also the charges for processing, and pre-payment options and charges.
· If an HFC increases any charges or introduces a new charge, it should be notified one month prior to the charges being levied.
· HFCs should provide service guide/tariff schedule.
· HFCs should provide their customers information about the penalties liable to be levied in case of violation of any terms.
· Whenever loans are given, HFCs should explain to the customer the repayment process by way of amount, tenure and periodicity of repayment. However, if the customer does not adhere to the schedule, a defined process in accordance with the laws of the land shall be followed for recovery of dues.
· HFCs should keep end-users informed about changes in interest rates, charges, terms and conditions through 1. Putting up notices in their branches 2. Through telephones or helplines 3. On the company’s website 4. Through designated staff/help desk

Insurance Articles

Detariffing and your motor insurance premium

Detariffing is finally a reality .Here’s the likely impact on your motor insurance premiums.

Till last year, there was little to distinguish between auto insurance plans offered by various insurers. That’s because policies were classified by the Insurance Regulatory and Development Authority (IRDA) as ‘tariff’ policies, on which the regulator set the minimum premium chargeable and hence defined the nature of the policy offerings. Since the 1st of January 2007, detariffing has been introduced by IRDA. Under this regime, general insurance companies are free to set differentiated premiums for most of their products. So, now instead of one size fits all policies, companies can charge different premiums to different consumers, based on their own business analysis and estimation of the consumer’s risk profile. The area which is likely to see the most action is motor insurance which accounts for close to 50 per cent of the general insurance business.

Motor Insurance covers the vehicle and the vehicle owners’ liability towards third parties (or accident victims) and is mandatory. Infact, without third-party liability cover, you cannot get the car onto the road. As per the detariffing rules, IRDA has allowed insurers to marginally increase the rates for third-party insurance — an unprofitable cover. At the same time, it has freed pricing on motor vehicle insurance. In the detariffed scenario, insurance companies will arrive at premiums based on their assessment of risk on a case-to-case basis. As insurance companies are not allowed to vary the scope of cover with respect to the products on offer, this shall ensure a continued consistency in coverage given to the insured. Combined with an appropriate risk premium, the customers with a good track record will be the biggest gainers. In addition, insurers will focus on customer service as a key differentiator.

One area which the IRDA was concerned about while undertaking this initiative was rampant undercutting .To pre-empt this possibility, the IRDA has allowed insurers to reduce the tariff only up to 10 per cent of the current tariff. Also, they are not allowed to change the tariffs for the next six months. Moreover, rating in the detariffed scenario will be done as per merits of the risk. Hence, bad risks cannot be cross subsidized by the good ones. Here’s a look at the factors which will decide your premiums on comprehensive motor cover:

1) The brand and the model of a car will decide the insurance premium that its owner has to pay. There will be factors that work on a portfolio level which are related to the vehicle model (serviceability, ease in repairs, availability of spare parts, etc.) and location.

2) Parameters like the date of purchase, number of accidents, driver-driven or owner driven car will also be among the factors that will determine the premium.

3) A person who has invested in safety features, maintains the vehicles well, has a favourable claim profile, etc. would stand to benefit. All-in-all, customers with a good risk profile would enjoy lower premiums.

4) Models from companies which have a poor distribution network and spare parts with high cost will attract higher premiums.

5) The cost of third party compulsory insurance cover is set to increase by 150 per cent. This will mostly affect commercial vehicles since most private vehicle owners prefer a comprehensive cover.

For 2007, policy wordings aren’t going to change and hence only the rating will affect the premium. In 2008, the condition of the vehicle, its age, maintenance and the insured’s claims history will have a big impact on the rates. When this happens motor vehicle owners can expect customized covers suited to their exact requirements. Moreover, there will be no compulsion for them to pay for cover that they do not require. Customers should however realize that the best rates are not necessarily the lowest rates. In a fully de-tariffed 2008, where a low rate may be offset by a reduced coverage, it becomes imperative that the insurance contract is read and understood fully before being entered into. Hence , in order to derive maximum efficiencies, it is critical that you understand the product that you are purchasing very well.

Take-home - Globally, it's the advent of insurance brokers that marks the complete opening up of the insurance industry. The Indian insurance industry has only recently crossed that milestone, although insurance broking hasn’t fully taken off yet. Unlike agents, who peddle only one insurer’s products, a broker will offer products across insurers, and will be equipped even to get insurers to tailor products to your specific needs. For instance, if you’re a professional who drives from home to work everyday vis-à-vis a regular outstation driver, your policy and hence premium will be entirely different. So , make sure you have a good motor-insurance broker in order to get the best deal.