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

Updated on December 28, 20185 mins read
Housing finance company, Housing Finance

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 HFCs 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. Previously, HFCs offered higher loan amounts than Banks due one factor. This was the ‘Stamp Duty & Registration charge’. The Stamp Duty & Registration charges are calculated at 6-8% of the property cost and paid separately to the government. The reason that there was a difference in the loan amounts was that Banks offered a loan only on the Property Cost while HFCs offered a loan on the Property Cost +Stamp Duty & Registration cost. Even with the same Loan-to-Value ratio, HFCs could offer a higher loan amount on the same property. THIS IS NOT TRUE ANYMORE. On 8 April 2015, NHB released a circular (http://www.nhb.org.in/Regulation/NHB(ND)-DRS-Policy-Circular-69-2014-15.pdf) which stops HFCs from increasing the loan coverage by including Stamp duty and Registration charges for properties over Rs.10Lc in value.

Banks which are HFCs

Are you with us so far? Great! Now, here’s where things get a little tricky. Some Banks like HDFC and Punjab National Bank are Banks but operate as HFCs when they provide housing loans. You should always check whether the bank you are approaching functions as an HFC or a bank. Here is a comprehensive list of Housing Finance Corporations in India   Comparison Summary Here is a table to summarise the differences between HFCs and Banks:

Parameters HFC Bank
Funds Obtained Borrowed from Market or Banks Current/Saving Account deposits
Regulating Authority NHB RBI
Interest Rate Calculation PLR – Spread Base Rate + Margin
Loan Eligibility Higher amount Lower Amount
Rigidity on Credit Score Lenient Rigid
Rigidity on Documentation Lenient Rigid
Type of Loans Only housing & property loans Various types of loans

Benefits of HFCs over Banks

  • Leniency in documentation, eligibility and credit score assessment
  • Quicker loan disbursal

Benefits of Banks over HFCs

  • Lower interest rate
  • Long term savings
  • When RBI reduces Base Rate, the benefit is promptly passed to the customer

Hopefully, you now have a better understanding of Financial Institutions like Banks and HFCs. Often people make the wrong decisions due to misconceptions and then suffer for years and years. Which is why you should always research as much as you can before finalizing your loan. Now that you have officially been initiated into the world of Housing Finance, take some time and explore our blog for more information that will save you money and hassles in the future. Enjoy a stress-free financial future!

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