The market has not yet reacted to the rate cuts on home loans, stock prices are not affected

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The housing finance majors are trying to create demand during the holiday season by cutting interest rates. The HDFC mortgage company cut its minimum mortgage rate to 6.7 percent. NBFC is responding to cuts by the State Bank of India (SBI), Bank of Baroda, Kotak Mahindra Bank and Punjab National Bank (PNB). Most offer rates between 6.5 and 6.9 percent.

Each lender views the mortgage market as a relatively safe flow. Mortgage defaults are rare and, at least in theory, a recoverable asset exists in the event of default. Since business NPAs are quite high, home loans are therefore a target.

Second, interest rates are low and are unlikely to rise as long as the RBI maintains liberal monetary policies. The central bank has embarked on the economic recovery and has kept its key rates low, despite a surge in inflation. The real interest rate on treasury bills is close to zero. The economic recovery will bring India back to 2019-2020 (pre-pandemic) GDP levels only in 2022-2023. As a result, policy rates can remain low for an extended period.

This is a 30 to 45 basis point discount for most lenders. HDFC has maintained a 2.3% credit spread over its portfolio for several years. Individual loans (the majority are mortgage financings) have a spread of 1.93% in the April-June quarter of 2021. The overall cost of borrowing for HDFC in the first quarter of 2021-2022 was 5.9%, while its combined yield was about 8.2%. The cost of funding was 6.7% in fiscal year 2020-2021 – it has dropped significantly. The NBFC can expect the cost of financing to continue to decline. Banks have lower funding costs. Similar logic applies.

From a lender’s perspective, this makes sense. HDFC offers this rate for a limited period, but if other lenders stick to low rates, it may extend the discount. If future home owners take out these loans, we’re talking about an average payback period of 11 years. Since mortgages are generally at variable interest, lenders can reasonably expect to even out spreads over the long term of the mortgage.

From a homeowner’s perspective, the key factors are affordability and EMI, rather than calculations of small interest rate differentials, which can add up to large sums over 11 years or more.

One point made by HDFC and other lenders is that housing affordability has improved, calculated based on the average annual income of homeowners versus the average cost of mortgaged property. This is true since real estate prices have stagnated or fallen. But that could, in part, be misleading since only people who can afford to take out a mortgage and pay it off can apply for loans.

It’s a small percentage of the population, if we look at a second statistic. India has a low mortgage penetration of just 11 percent of GDP. It is around 20% for China and over 50% for the United States. So there is an advantage, but also an implication that most Indians cannot afford to buy real estate.

There have been concerns about the “K-shaped” economic recovery, with high income earners doing much better than middle / low income earners. This could mean greater demand for mortgages in the upper segment of the market, where sensitivity to rate cuts is lower. The stock market has not really reacted in one way or another to the rate cuts as stock prices are more or less affected.

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