State Bank of India chairman O P Bhatt today said at a Indian Banks Association conference, that as part of the housing stimulus package, nationaslised  banks will offer home loans up to Rs5 lakh at 8.5 per cent and  loans between Rs5 lakh and Rs20 lakh at 9.25 per cent

Media reports had earlier said the public-sector banks are on verge of reducing home-loan interest rates to 7.5 per cent for loans of up to Rs5 lakh and 8.5 per cent for loans between Rs5 lakh and Rs20 lakh.

Today's  reduction in interest rates is the ourcome of Indian Bankers Association (IBA) announcing a stimulus package valid till 30 June 2009.

However, Existing borrowers will continue paying higher interest rates, as these rates will be applicable only for fresh loans. However, existing borrowers can switch to cheaper loans by making a one-time penalty payment.

The government may bear some fiscal burden in the process. Banks have been reluctant to reduce rates, as their borrowing cost is extremely high.

From retail customers, banks have been borrowing via the fixed deposit route for rates between 10 per cent and 11 per cent. Bankers may resort to a reduction in their deposit rates in order to reduce their cost of funds

As many as 80 per cent of India's home loan borrowers have taken less than Rs20 lakh as loan. Floating interest rates stand at 11 per cent now.  

The package will include measure like relaxing norms related to risk-weights and margin requirements for home loans, which would enable banks to lend more in these categories.

At present, the risk-weight for home loans up to Rs20 lakh is 50 per cent.

To facilitate banks to lend at these rates, sources said that RBI may relax risk weights for these categories of housing loans if the banks reduce the margin money from 25 per cent to 10 per cent. At present, the risk weight is 50 per cent for home loans up to Rs20 lakh.

Some of the other incentive may include a reduction in the margin requirement, or the part of the loan paid by borrower upfront, will mean that banks will have to provide more funds to the extent of the increase in the actual loan amount. 

Other incentives that were discussed included a waiver of processing charges for home borrowers and a five-year lock-in period on interest rates.