Housing Finance Corporations (HFCs) And Banks: Who Wins?

What is a Housing Finance Corporation? Is it different from a bank? What is National Housing Bank? What is Base Rate and Benchmark Prime Lending Rate? What is my name?

These are some of the questions that normal; non-finance people have when they are first introduced to the concept of Housing Finance Corporations. If explained improperly, it is very difficult to grasp this idea and you might be left with more questions than you began with. The following article exists for the sake of simplifying this concept and preserving your sanity.

Let’s make you an expert in 10 minutes!

Housing Finance Corporations & Banks

Most of us spend our lives believing that home loans are given out by Banks and that the story ends here. It is a simple but inaccurate view of the world because in reality there exists a separate set of entities called Housing Finance Corporations or HFCs. And while HFCs perform the same basic role as Banks, there are many small differences that exists between these two Financial Institutions.

1) Types of loans provided

This is the most fundamental difference between these two types of loan providers. HFCs only provide housing-related loans like home loans, loans against property and construction loans while Banks provide different types of loans like personal loans, auto loans as well as home loans.

2) Where do they get their funds?

Logically, you can lend money only if you have money. The same principle is applicable for loans. Both HFCs and banks need to generate a pool of funds before they can start disbursing loans to customers. The difference lies in the way these funds are generated.

Banks lend loans by using the money deposited in Current and Savings Account (CASA) by their customers. The same money that you deposit in your Current/Savings account is disbursed by the Bank as a loan. This is profitable for Banks because the interest they pay customers on CASA deposits is lower than the interest they receive on loans.

HFCs do not have access to CASA funds and therefore generate funds through different ways. Reputed HFCs like HDFC, LICHFL and DHFL raise funds from the public as well as by borrowing from banks. Smaller HFCs mainly rely on borrowing money from banks. Because they use money borrowed from banks, the cost of generating funds is higher for HFCs than banks. This is one of the reasons why Housing Finance Companies charge a higher rate of interest.

3) Which authority sets the rules?

Financial institutions need an governing authority to make sure that transactions are happening in a fair and systematic manner. HFCs and Banks are governed by two separate authorities – Reserve Bank of India and National Housing Bank respectively. NHB is a part of RBI.

In 1988, National Housing Bank (NHB) was established to regulate HFCs, although some aspects of HFCs are still regulated by the RBI. And so arose different sets of norms for HFCs and Banks to follow. Thus, we come to our 4th point.

4) How is the Rate of Interest calculated?

As mentioned above, HFCs are regulated by NHB and Banks are regulated by RBI. Because of this, there are separate methods for calculating the interest rate on home loans.

Before we get into details, let me introduce you to two sets of terms:

1) Prime Lending Rate (PLR) & Discount

2) Base Rate & Spread

The Prime Lending Rate and Discount are the factors used by HFCs for deciding their interest rate. The PLR is calculated by HFCs based on the cost they incur for raising their funds along with a certain profit margin. The method for calculating PLR is not known. Let’s say an HFC’s PLR is 16%. What it will do now, is discount this rate by a certain amount, say 5%. This Discount is decided by each individual HFC.

Interest Rate = PLR – Discount = 16-5 = 11%.

Banks calculate interest rates in a slightly different way. First, they calculate something called Base Rate. The method of calculating the Base Rate is decided by the RBI. Base Rate is the minimum rate at which that Bank can lend money for any loan and like PLR, it also includes a certain profit margin. Let’s say this Base Rate is 8%. Loans are hardly ever given on the base rate. The interest rate is generally higher than the Base Rate. To calculate the interest rate, Banks add a Spread on top of the Base Rate. If a particular Bank’s Spread is 0.25%, then it’s Interest Rate = Base rate + Spread= 8+0.25 = 8.25%.

Note: According to RBI regulations, once a customer has been given a loan, the bank cannot change that customer’s spread unless there is a change in his/her creditworthiness.

5) Difference in loan amount

HFCs no longer offer a higher loan amount than banks, but many people still think that they do. Allow us to clarify this point for you.

[Source: https://www.switchme.in/blog/2016/03/housing-finance-corporations-hfcs-and-banks-who-wins/]