It is now very obvious why the RBI is pushing to formalize the linking of loan as well as deposit rates to external benchmark such as repo rate. Yes! You know it right this is because the new system when in place throughout the banking channel will take care of the concerns around efficient transmission of key monetary decision to end consumer whether he or she be borrower of loan or a depositor with the financial institution. While SBI spearheaded the move in July this year with the introduction of RLLR linked home loans, few others from the public sector space including the likes of BOB, OBC, Syndicate Bank have announced or launched similar retail loan products with floating rate option.
In the FIICI convened meet, Shaktikanta Das again hailed the step as it will also ramp up the ailing economy which is witnessing slowdown across sectors. "I think the time has now come to formalize the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks, will be taken by RBI", said Das on the sidelines of the conclave organized by the industry body FICCI and IBA on Monday.
So, if you also without much know-how on the new product i.e. repo rate linked loan are considering it among the different options for your home loan, here are the finer details on SBI's RLLR home loan and how it differs from the more prominent MCLR loans:
Before going ahead, with the low-down on the new product category, we will discuss:
How and what led to the origin of RLLR and MCLR-linked loans?
RLLR loans have been introduced for quicker and transparent transmission of monetary policy decision or change in key policy rate i.e. repo rate to consumers. RLLR or repo rate linked lending rate will be tied to the RBI's repo rate which might get revised very often as in the current calendar year (a rate cut of 110 basis points so far in 2019, with the latest steep cut of 35 bps on August 7) in view of the economic slump and controlled inflation levels.
In the current regime, where most retail loan products are indexed to bank's cost of funds or MCLR based loan, banks have since the introduction of this system i.e. from April 1, 2016 shown reluctance to pass on the complete benefit of rate cut to customers. It is to be highlighted that barring the latest rate cut, of the 90 basis points reduced in repo rate, only 29 bps is said to be transmitted. Also there is a provision attached to the MCLR system of that of the reset period clause which makes the transmission even slower as for the existing borrowers the rate is revised only after the reset period. Interestingly, in an interest rate reducing cycle, smaller the reset period greater is the benefit to borrower. RBI allows a maximum reset period of 1 year while it can be as low as a quarter in case of very few of the banks.
MCLR came into picture replacing the earlier base rate system such that banks can peg their loan offerings to their marginal cost of funds. It is indeed the minimum rate below which a commercial bank is not allowed to lend. Typically, an internal benchmark or reference rate in contrast to the repo rate, for arriving at the MCLR cost banks consider the incremental cost linked to arrangement of additional rupee for a prospective borrower. MCLR rate is declared month on month individually by banks and it is cheaper for banks that have a good savings and current deposits.
1. Interest rate for SBI’s RLLR home loan versus MCLR loans:
Now after we have come to establish the reasons what led to the introduction of the new repo-linked loan: We'll detail on some of the key features of the RLLR linked home loan and its comparison with MCLR loan.
For RLLR home loan, interest rate is based on the RBI's repo rate and as it is transmitted a month after the policy rate revision, it is calculated as though.
Current RLLR - repo rate in July + 2.25% = 5.75+2.25
This establishes SBI's RLLR to be 8.0% per annum.
And after the RBI's repo rate cut of 35 bps in its August 7 monetary policy meet, RLLR will come down in the same proportion to 7.65% from September 1, 2019. So, borrowers get the benefit of rate cut on an immediate basis. Though, it is to be noted that there is mark-up attached to the RLLR that increases the effective loan rate.
In the case of MCLR-pegged loans wherein for most of the banks 1-year MCLR stands between 8-9%, interest rate is indexed to the bank's cost of funds. And even when the banks reduce their MCLR rate like they did it this time by 5-25 basis points across tenors after the RBI's repo rate cut of 35 bps in August, existing loan borrowers will not benefit immediately. Thanks to the reset period clause under MCLR which varies from banks to banks.
Illustration explaining when the MCLR rate cut is transferred to borrowers: Say you took a home loan from SBI on July 1, 2019 and the bank has revised its MCLR rate lower in August. But despite this your interest rate on loan will continue to be the same until June 30, 2020. And it is only on July 1, 2020 that the MCLR rate cut will be transmitted to you as a reduced interest rate on your borrowing. So even with the MCLR cut in August this year, your EMIs will continue to be the same until the reset term becomes applicable.
Thus, RLLR will be highly volatile in comparison to the MCLR rate-based retail loan products as for them the banks offer a reset clause of either 3 months, 6 months or a year.
Difference in loan repayment method in case of repo-rate linked home loans:
Loan repayment method in case of repo-linked home loan is not the same as a regular home loan EMI payment. Interest is to be paid monthly as and when it becomes due and will vary whereas the principal amount will remain the same throughout the loan tenure. In addition, a minimum of 3% of the home loan principal amount is to be repaid every year in equated monthly installments (EMI) before the borrower turns 70 years.
While in the case of MCLR-linked home loan repayment, there will be one decided EMI that will remain the same until outstanding loan repayment. For such loans, in the initial years, interest portion is on the higher side when compared to the principal repayment.
Repo-linked loans to be cheaper by 25-35 bps yet volatile:
For borrowers opting for the new repo-rate linked loan products, the benefit will be to the tune of 25-35 basis points. One basis point is one-hundredth of a percentage point. In case of SBI, one-year MCLR as of August 10 stands at 8.25%. So the effective interest rate on SBI's MCLR linked loan with a floating rate option for loan amount in the range of Rs. 30 lakhs to Rs. 75 lakhs for a salaried class customer works out to be 8-65-8.75%.
And if the same individual chooses the new repo rate linked loan product, the effective interest will be calculated as though: repo rate + 2.25% that makes up repo-linked lending rate (RLLR) and an additional 40 basis point. So, considering July's RLLR at 8%, effective rate will be 8.4%. And in September, after the latest repo rate cut of 35 basis point is transmitted to the repo-linked products, the effective rate will be 8.05% (5.40% repo rate+2.25% +0.4%).
In case of MCLR loans, banks can charge this amount over and above the MCLR rate depending on loan amount, ltv, tenure, gender and risk profile.
In case of RLLR loan, customers can be charged spread of between 40-110 bps depending on loan amount and risk profile
For whom MCLR or RLLR home loans suit:
MCLR-linked loan is for borrowers who do not expect much changes in their EMI and can afford to pay the decided EMI all through. Nonetheless, RLLR would suit customers who can go by the extreme volatility in interest rate as there can be a case when RBI revises the policy rate lower or higher at all 6 of the bi-monthly policy review meet.
So, don't just take the pricing factor of RLLR loan which is acclaimed to be cheaper to be your determining factor for the home loan choice.