Most borrowers look at the change in repo rate, decided by the Monetary Policy Committee, as an indication of the increase or decrease in their existing loan's EMI or a loan they were intending to take.
The MPC's decision announced by the RBI governor Shaktikanta Das on Thursday to reduce the repo rate by 25 basis points to 6.25 percent may be seen by some as a possible reduction in interest rates on loans. However, it is advisable to not base your decision to take a loan over this.
Bank of Baroda increased its 1-year MCLR (Marginal Cost of Funds based Lending Rate) by 10 basis points to 8.75 percent this week even before the monetary policy meet. HDFC Bank had revised its MCLR earlier this year to 8.75 percent for the 1-year tenure as well.
The increase is most likely due to the rise in the cost of funds for specific banks. The increase in MCLR, (which is the minimum interest rate below which the bank won't lend) will mean an increase in your EMI burden.
As the repo rate is the rate at which RBI lends to banks, a deduction in it will definitely mean that the cost of borrowing for the banks will reduce, which means that it is likely they could reduce their interest rates. However, the MCLR is not immediately reflective of this change. Additionally, the repo rate is just one of the many factors that MCLR is based on.
Further, your EMI is not singularly based on MCLR. It depends on:
- Bank's MCLR
- Reset date
All loans taken after 1 April 2016 are linked to the lender's MCLR. These rates are set for various tenures- overnight, one month, three months, six months, one year, two years, three years. Home loans are typically based on 6 or 1-year MCLR.
As mentioned before MCLR is the minimum interest rate below which the bank will not lend money. This means that the interest rate at which the bank will lend could increase based on the applicant's credit profile. If the branch feels that the loan applicant is a risky borrower, the interest rate could go higher. It ideally fluctuates by 0.25 to 0.50 percent.
Banks have the freedom to decide their spread of interest rates to attract customers or protect their funds.
On loans before 2016, the interest rates were based on "base rates," which meant that if you had opted for a floating interest rate on your loan, it would be immediately reflective of the rise or fall of the repo rates.
However, under the MCLR, RBI rules home loan interest rates are re-priced periodically. The period of the reset in interest rate has to be one year or lower and this is mentioned in the terms of the loan contract.
Often home loans are linked to one-year MCLR. So if you had taken a home loan in say, August 2018; despite the change in MCLR in the following months (based on monetary policy), your loan's interest rate will only be revised in August 2019.
What should you do?
Home loans are long-term loans which stretch over a period of 10 to 20 years. In the next 20 years, the economy (on which the repo rates are based) could move both ways and there will be many changes in the monetary policies. It, therefore, becomes pointless to base your decision to opt for a home loan on the monetary policy.
Pick some banks and compare the interest rates and opt for the one that suits you best. If you already have a home loan, wait for the MCLR to reflect in the interest rate at the time of the reset date. If you find another lender that will give you a better rate than your existing bank, you can make the switch.
For those who are eligible under the Pradhan Mantri Awas Yojana (PMAY), the Credit Linked Subsidy Scheme for the Middle Income Group (CLSS for MIG) has been extended to 31 March 2020, giving you more options to choose from.