The recent cuts in the policy rates by the Reserve Bank of India (RBI) send out a positive signal to an industry which is recovering from a slowdown in recent times. The retail loans segment is quite sensitive to changes in interest rates as any changes in the policy rates have an impact on the cost of funds for the lenders.
The cost of funds is something which almost directly impacts the end user and thus rates become a key factor for this segment.
A drop in the policy rates generally spurs demand in housing and auto industries since demand in these industries are dependant to a large extent on the credit available. Consumers buying houses or cars on loan will be fairly sensitive to interest rates on these loans.
However, the housing industry and home loans in particular are more sensitive to changes in interest rates as compared to the auto industry.
Before we get into the financial aspects of home loans and auto loans, let us first get a little perspective on both. Home loans are loans provided by financiers (banks and housing finance companies) to individuals who are generally purchasing residential property either a newly constructed property or an existing property through a resale purchase transaction. The term of a home loan can be up to 25 or even 30 years. Auto loans, in comparison, can be given for up to five or seven years.
If we cut across social strata, a person who is purchasing an automobile is not impacted as much by interest rate movements as compared to a person who is purchasing a house for two main reasons: one, the quantum of the loan amount is much higher for a home loan and two, a home loan is a long term liability as compared to an auto loan.
Purchasing a house is more of a need-based purchase as compared to purchasing a car for personal use which is more of a lifestyle or a want-based purchase.
Another major differentiator is the fact that a home loan is a loan for acquiring an appreciating asset (under normal macroeconomic situations) whereas an auto loan is a loan for acquiring a depreciating asset.
Now, coming to the financial aspects of both these types of loans — let us compare an entry level vehicle purchase auto loan with an entry level house purchase loan in an average Indian city.
The EMI per Rs 1 lakh for an auto loan (for 5 years at 10 per cent) is Rs 2,125, while the same for a home loan (for 20 years at 10 per cent) is Rs 965, in a hypothetical scenario where both the interest rates are the same.
If we were to compare home loan and auto loans under a falling interest rate regime, for every 1 per cent drop in Interest rates, the EMI for a Rs 5 lakh loan decreases by Rs 260 whereas the EMI for a Rs 30 lakh home loan decreases by Rs 2,160. As it can be seen the impact of a similar drop in interest rates is much higher in the case of the home loan.
Also, since a home loan is a long term loan, this translates into a much higher credit eligibility for a home loan for an end user as compared to an auto loan. Hence, home loans are impacted to a greater extent with a small decrease in interest rates as compared to an auto loan.
With increasing loan eligibility amounts, the purchasing power gets a bigger spurt. The interest impact hence gets magnified for a home loan as compared to an auto loan.
There are other macroeconomic factors governing the housing sector in particular. A very important factor is that rural housing and rural housing finance are a priority sectors as per National Housing Bank. We as financiers have an unsaid responsibility of supporting housing development in rural areas, and provide more impetus towards this sector.
The author is MD, Tata Capital Housing Finance Limited