Factors Influencing the Home Loan Interest Rate

Ever wondered how the banks and loan lending institutes set the home loan rates? We discuss all the factors that influence the home loan rates:

1. MCLR (or Base Rate):
The base rate is the minimum rate that is set by the Reserve bank of India to make sure that the credit markets are more transparent and to ensure that the banks pass the lowest cost fund to their customers. The banks are not allowed to set the home loan rate below the base rate.

From April 1, 2016, RBI introduced a new method of calculating the benchmark for the lending rates for the banks knows are Marginal Cost Fund Lending Rate (MCLR).  According to the same, the banks will have to set up five different benchmarks for the different time periods (overnight, one month, three months, six months, and one year). The base rate will be assessed according to the MCLR calculation, influenced by the factors like marginal cost of funds, tenure premium, negative carry on account of Cash reserve ratio (CRR) and the operating cost.
 
2. Repo rate:
It is the rate at which RBI lends money to the banks in the event of any shortfall. It is the financial instrument used to control the inflation. If RBI wants to put more money in circulation, then it will lower the Repo rate. Whenever RBI raises or lowers the Repo rate it affects the interest rate on the banking products like loans and mortgages.
 
3. Reverse Repo rate:
It is the rate at which the RBI borrows the money from banks. It is the financial instrument used by the central bank to control the supply of money. The increase in reverse repo rate will lead to the decrease of supply of money in the country and vice versa.
This gives the bank a leverage of parking their money with the RBI. This money will not be available for the credit or supply in the market. The increase or decrease in the reverse rate directly affects the lending rate of loans.
 
4. Cash reserve ratio (CRR):
CRR is the fraction of the total deposits by the customers which the banks have to hold as the reserve with the RBI. This is done t make sure that the banks don’t run out of cash in case the customer demands payment of their money. CRR is a very important monetary policy to control the money supply in the country. For example, when the bank’s deposit increases by Rs 100 and if the CRR is 9 percent then the bank will have to hold Rs 9 with the RBI and use Rs 91 for the investment or lending purpose.
 
5. Statutory Liquid Rate (SLR):
Every bank has to maintain a certain percentage of their ‘Net Demand and Time Liabilities (NDTL)’ as liquid assets in form of cash, gold, etc. his ratio between liquid assets and NDTL is called Statutory Liquid Rate. Maintaining SLR restricts the banks to pool more money in the economy. This again impacts the lending rates.
 
6. Benchmark Prime Lending Rate (BPLR):
BPLR has now left its relevance and is only applicable to the loans sanctioned before 2010. But it is important to understand it.

BPLR is the rate at which the banks lend the money to their credit worthy customers. it was introduced to ensure transparency in the loan pricing and giving out the loan to the applicants according to their financial ability.

For example, if the BPLR rate is 10 percent and the customer already has taken different loans but wants to take another one and has never been late or defaulted on the loan repayment. Then the banks can give him a loan lesser than 10 percent.  In past, there have been cases that the banks have given out the loan for as low as 4 percent. RBI hence came up with base rates so no bank can lend money below the rate.