Everything You Need to Know About Repo Rates Linked to Home Loans
Aug 26, 2019 Home Loan
In May 2019, India’s largest bank, State Bank of India unveiled their plan to link the home loan and deposit rates to the repo rates. Following the suit, many state-run financial banks and institutes have joined the bandwagon. Among the banks that have decided to link their home loan and deposit rates to the repo rates are Syndicate Bank, Bank of Baroda, Bank of India, Union Bank, Indian Bank, and Allahabad Bank.
If you are an existing home loan borrower who is servicing the home loan based on MCLR, then you will have the option to switch to the new repo linked lending rate (RLLR). The new home loan borrowers will have the option to choose between the two.
MCLR vs. RLLR
In April 2016, RBI introduced the MCLR system replacing the base rate system for the loans. The MCLR system aimed at ensuring better policy transmission to the customers. However, it only made a little impact. The RBI has reduced their basis points by 75 this year, but the banks have only reduced it to 29 basis points.
MCLR is the internal benchmarking, and the banks reset the home loan rates only at the intervals that are specified in the loan agreement. The rate cuts that were implemented by the RBI were not being passed on to the customers as much as it was expected. Generally, the home loan agreement has the home loan reset clause once a year. So even if the RBI has reduced the repo rates multiple times a year, the loan borrower only has the liberty to reset it once a year.
Most of the borrowing from the banks comes from the deposits and just 1% from the RBI, which is the primary reason why the banks have shown their inability to reduce the repo rates further. This is also one primary reason why the banks reduce the deposit rates first and then the loan rates.
In case of the MCLR based loan, the banks have to factor in their cost of the deposit, operating cost, etc. apart from the repo rates while calculating the rates. Therefore, the MCLR based home loans will have a slower transmission of the policy rate change.
Because of the limited success of the MCLR based rates, in 2018 RBI directed the banks to switch to an external benchmarking system which will allow the borrowers to reap the benefits of change in monetary policy.
Switching to home loan based on RLLR
Before we agree, we must understand several aspects of the MCLR and RLLR. Under the MCLR regime, the decision to charge additional interest on top of the repo rate lies with the bank. Currently, the repo rate is at 5.4 percent, but the Bank of Baroda charges 8.35 percent interest on the repo rate linked home loans. The difference between the two rates is 295 bps. However, when compared to the MCLR of 8.45 percent, the repo rate based home loan is 10 bps cheaper.
Once every two months, the RBI announces their monetary policy. During that time, it evaluates whether it will be beneficial to reduce the repo rate, maintain it, or increase it. Interest on the home loans linked to the repo rates will change as soon as the RBI changes their policy. That means that the one year reset clause that the banks have will be out of the window.
With the home loan interest linked to repo rates, the home buyers will be able to enjoy the benefits in must faster way. However, one must remember that it goes both ways. If the RBI increases their repo rates, then it will be effective immediately without any doubt.
It is also important to note that when the repo rate reduces, the home loan rates reduced too, along with the deposit rates.
If you are an existing home loan borrower who is servicing the home loan based on MCLR, then you will have the option to switch to the new repo linked lending rate (RLLR). The new home loan borrowers will have the option to choose between the two.
MCLR vs. RLLR
In April 2016, RBI introduced the MCLR system replacing the base rate system for the loans. The MCLR system aimed at ensuring better policy transmission to the customers. However, it only made a little impact. The RBI has reduced their basis points by 75 this year, but the banks have only reduced it to 29 basis points.
MCLR is the internal benchmarking, and the banks reset the home loan rates only at the intervals that are specified in the loan agreement. The rate cuts that were implemented by the RBI were not being passed on to the customers as much as it was expected. Generally, the home loan agreement has the home loan reset clause once a year. So even if the RBI has reduced the repo rates multiple times a year, the loan borrower only has the liberty to reset it once a year.
Most of the borrowing from the banks comes from the deposits and just 1% from the RBI, which is the primary reason why the banks have shown their inability to reduce the repo rates further. This is also one primary reason why the banks reduce the deposit rates first and then the loan rates.
In case of the MCLR based loan, the banks have to factor in their cost of the deposit, operating cost, etc. apart from the repo rates while calculating the rates. Therefore, the MCLR based home loans will have a slower transmission of the policy rate change.
Because of the limited success of the MCLR based rates, in 2018 RBI directed the banks to switch to an external benchmarking system which will allow the borrowers to reap the benefits of change in monetary policy.
Switching to home loan based on RLLR
Before we agree, we must understand several aspects of the MCLR and RLLR. Under the MCLR regime, the decision to charge additional interest on top of the repo rate lies with the bank. Currently, the repo rate is at 5.4 percent, but the Bank of Baroda charges 8.35 percent interest on the repo rate linked home loans. The difference between the two rates is 295 bps. However, when compared to the MCLR of 8.45 percent, the repo rate based home loan is 10 bps cheaper.
Once every two months, the RBI announces their monetary policy. During that time, it evaluates whether it will be beneficial to reduce the repo rate, maintain it, or increase it. Interest on the home loans linked to the repo rates will change as soon as the RBI changes their policy. That means that the one year reset clause that the banks have will be out of the window.
With the home loan interest linked to repo rates, the home buyers will be able to enjoy the benefits in must faster way. However, one must remember that it goes both ways. If the RBI increases their repo rates, then it will be effective immediately without any doubt.
It is also important to note that when the repo rate reduces, the home loan rates reduced too, along with the deposit rates.
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