Repo Rate vs MCLR linked Home Loans

With the recent introduction of 'Repo Rate' based Home Loans from the existing 'MCLR based' Home Loans, the Home Loans are set to change - yet again.
Read on to know more..

Banks give money to individual seekers like us, as well as to businesses - as a loan. 

From where do Banks get the money to give us such loans? 

They get it through various deposits that their clients (like us) make. 

And from where else? 

Major chunk of the money that the bank gets, comes from the federal bank i.e. RBI in our case. What is the rate of interest that RBI charges from the banks? Welcome to the world of Repo Rate.

What is Repo Rate?

In short, Repo Rate is that Rate at which banks can borrow money from RBI. The lesser the rate, banks can borrow cheaper and therefore lend cheaper to businesses. This fuels businesses to borrow more and fuels the economy. The reverse of it is also true if the RBI decides to increase the Repo Rate.

[ Recommended Read --> Repo, Reverse Repo and CRR ]
Repo Rate is announced by RBI from time to time (usually every quarter). You can have a look at the latest rates from RBI at the RBI Official Website.

What is MCLR?

The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate that a bank can lend at - to businesses and individual loan seekers like us. MCLR is a tenor-linked internal benchmark, which means the rate is determined internally by the bank depending on the period left for the repayment of a loan. Banks review and publish MCLR of different maturities, every month. 

MCLR has been made applicable w.e.f 1st April 2016 as a counter to the earlier existing base rate system.

Relationship between Repo Rate & MCLR

If banks borrow from RBI at the rate of 6% (Repo Rate), then there is no rocket science in stating the fact that they will obviously be lending to businesses and (home) loan seekers at a rate higher than 6%, let us say 8% (MCLR). So, the MCLR will, in most circumstances, be higher than Repo Rate. 

As Repo Rate changes, MCLR also gets impacted. 

But remember that MCLR is not only a function of Repo Rate. It has various other dependency factors - some of which are internal to the bank. 

And therefore, though the banks also declare their MCLR Rate every quarter, it may or may not have a direct correlation with the Repo Rate.

Since April 2016, banks have been giving home loans based on MCLR. 

What is the biggest issue with MCLR Based Home Loan Rates?

Banks cannot lend below its MCLR, but may add a mark-up to arrive at the final home loan interest rate. However, proper transmission of Repo rates to the borrower by the banks remained a major concern and banks were found not to pass on the benefit of rate when RBI cut the Repo rate but were eager to raise the rates when the Repo rate inched upwards.

Example:
The one-year MCLR rates offered by SBI in October 2018 and August 2019 were 8.5 per cent and 8.25 per cent, respectively. 

Similarly, ICICI Bank’s one-year MCLR remained unchanged at 8.65 per cent from October 2018 to August 2019.

However, in this period, the Repo rate has been cut from 6.5 per cent to 5.4 per cent by the RBI. Clearly, banks have been slow in passing the benefits of rate cuts to borrowers.

How to address the issue?

To address this issue, RBI asked the banks to link home loan rates to an external benchmark rather than linking them to the MCLR, the bank’s internal benchmark. This directive was, however, kept in abeyance by the RBI and banks continued to offer MCLR linked loans. but now, things are changing. More banks are now offering Floating Home Loans based on Repo rate - which is an authentic external benchmark.

What will be the Home Loan Rate if it is linked to Repo Rate?

Repo rate linked lending rate (RLLR) is 2.25% over the Repo rate. Currently, the Repo rate is 5.75% p.a. RLLR becomes 8% p.a. An interest rate spread will be charged over RLLR. Therefore, you will be offered home loan at: Repo Rate + 2.25% + Spread.

A spread could be charged on the basis of your risk scores and other parameters.

RLLR is a nomenclature used by SBI to define this benchmark. Moreover, the spread of 2.25% over Repo Rate is also SBI’s choice. Other banks that link to Repo may choose a spread different than 2.25%.

Advantages of moving to Repo Rate Based Home Loans

1/ The general rate at which home loan is offered is definitely less for Repo Rate linked loans, as compared to MCLR linked home loans.

2/ Any downward movement in the Repo rate will keep the burden of interest rate lower  - either through lower EMIs or lesser tenure. So, in case of a change in policy Repo rate, the Repo linked lending rate changes from first day of the following month, which is a very effective move for borrowers.

Disadvantages of moving to Repo Rate Based Home Loans

1/ The product will help borrowers benefit from rate cuts in a transparent manner but may also mean a hefty increase in interest rates in case RBI increases Repo rate. In times of turmoil in international markets, sometimes the Repo rate is hiked very sharply and this may hurt borrowers though the likelihood of such an event is very limited.

2/ There are certain conditions that must be met before you become applicable for a Repo Rate linked Home Loan. As an example, SBI wants borrowers to have a minimum annual income of Rs 6 lakh to be eligible. Due to such annual income cap, a large part of the market is not be able to avail benefits of this scheme.

3/ Additionally, SBI charges a premium of 20 bps on the interest rate if the loan-to-value ratio is more than 80 per cent, which increases the borrowing cost. Banks also take into consideration the credit score of borrowers, so interest rate could end up at the upper-end of the range and further increase the borrowing cost.

Which banks offer Repo Rate Linked Home Loans?

State Bank of India (SBI) was the first to launch a Repo rate linked home loan scheme, effective July 2019. 

Following SBI’s foot-steps, Bank of Baroda too introduced a Repo-rate linked home loan scheme from August 2019. Other public sector banks are likely to follow suit soon.

Existing MCLR borrowers may get an option to switch to RLLR later with or without paying the switch fee.

Pre-Conditions to apply for a Repo Rate Linked Loan

1/ To be eligible for the SBI Repo rate linked home loan interest rate, one needs to have a minimum gross annual income of Rs 6 lakh.
2/ While interest is to be serviced monthly as and when applied to the account, a minimum 3 per cent of the principal loan amount should be repaid every year in equated monthly installments subject to liquidation of loan before borrower attains 70 years
3/ The maximum loan tenure is 33 years over and above maximum moratorium permitted of 2 years for under construction properties. So, the total loan tenor in such cases cannot exceed 35 year.

Summary

The loan linked to Repo rate is definitely 10-30 bps cheaper compared to the MCLR linked home loan scheme. So, in the long term, you will save on interest costs. It’s a positive development for borrowers.

Repo rate linked home loan product is targeted towards the faster transmission of policy interest rate changes to end consumers. One should consider this product if you are able to adapt to volatility in EMIs.

Regards

Manoj Arora
Official Website