In a scenario of rising interest rates, borrowers generally tend to hold back on procuring loans. To encourage them to take the plunge, banks often make the best of the situation by floating loan products that appeal to the customer.

In one such move, last month the ICICI bank introduced a new home loan product with fixed interest rate for the first and second years and floating rate thereafter. HDFC followed suit this month, by offering fixed rate for the initial three and five years.

While both banks refuse to call it a ‘teaser loan', and named it a ‘hybrid loan' or ‘dual interest loan', the banking industry on the other hand alleges that it is just another ‘teaser'.

In a more recent move, the Axis Bank launched a lifetime fixed interest rate loan product, Nischint at 11.75 per cent for up to a tenure of 20 years.

RBI's verdict

The RBI however, says that all dual rate loans are considered as teaser loans and banks must make the mandated provisions. It clarifies that such products are legitimate and they have not banned such products, but only laid down certain rules for them.

Banks, on the other hand, argue that as in the new scheme, the fixed rate offered in the initial years is on par with the current market rates and therefore, they cannot be called teasers and do not require higher provisioning. The floating rates on these products are linked to the bank's base rate and any cut in the minimum lending rate will also reduce their rates in future.

What is a Teaser Loan?

Teaser loans are adjustable-rate loans, where the borrower has a fixed lower interest rate for the first two or three years, which changes thereafter according to the prevalent market conditions.

SBI initiated the scheme in 2009 and almost all leading banks joined the bandwagon. Thus, teaser loans became very popular in a short span. They were also justified under the argument that when borrowers start paying higher EMIs after two-three years, their income would have gone up, offsetting the increased repayment liability.

In October 2010, the RBI intervened and increased the standard provisioning requirement for dual loan products from 0.5 per cent to 2 per cent in order to not encourage them beyond a particular bandwidth. Following this mandate, banks withdrew the schemes.

Good or bad?

But how do the new dual rate schemes work and what do they mean for a borrower? Take a hypothetical case.

When Avishka opts for a hybrid loan @10.75 per cent from HDFC, her EMI will be fixed for Rs 10,150 for 3 years against the loan of Rs10 lakh. If in case in 2013, the rates come down to 8.5 per cent, the EMI for 10 lakh will be Rs 8,680 but Avishka will continue to pay the same EMI for one more year. That means in the year 2013 alone, her loss will be Rs 19,360.

In 2009, when the economy was in good shape, interest rates were seen to head up steadily for some time. But in the current scenario, it is expected that, with the ongoing slowdown, interest rates may go up by a maximum of 50-100 basis points (0.5-1 per cent) in the near future and then will start to fall within two years.

So, if a borrower opts for the new scheme, most likely, he might lose out on the possibility of a downward trend in interest rates, as he will have to pay higher EMIs when interest rates fall. This is even more applicable in the case of a fixed interest rate loan that is currently being offered by Axis Bank.

In this interest rate scenario, a borrower needs to be very cautious in making a decision. If you believe predictions that rates will peak out over the next one year, the new dual-rate loans are not for you.

(The author is CEO, BankBazaar.com, an online marketplace for home, personal and car loans.)

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