If you have been up to date with financial news in the country, you would know that there was a further cut in basis points (bps) by the Reserve Bank of India by 25 bps, bring the total reduction in basis points this year alone to 135 bps. This is a cut in the benchmark lending rates of Reserve Bank of India to other banks in the country.
What does this mean to home loan borrowers like you, whether you already have an existing loan or are about to apply for a new one? Whether you have been paying EMIs on home loans for years, just a couple of months, or are about to start, the new bps cuts will have an impact on the EMIs you pay. Let’s understand this better.
The Reserve Bank of India had issued a circular to banks advising them to link their loan rates to that of the RBI’s repo rates. When banks agree to do this, they will be passing on the rate cut to customers, which means a cut in interest rates, which further translates into a reduction in your EMIs. What could be better than that?
Floating rate retail loans were supposed to be linked to this external benchmark from 1 October 2019. However, banks have been given the freedom to decide how much the spread should be over the external benchmark.
Depending on any changes in the external benchmark, there should be a revision or reset of the interest rates of these loans every three months. As long as the bps is being reduced, this is good news for borrowers of retail loans, especially home loans and auto loans.
Even if you have a loan whose interest rates are linked to the bank’s own MCLR, there will still be a reduction in EMIs as banks are expected to reduce their rates further.
Existing Home Loan Borrowers
The RBI had clarified that existing borrowers of home loans, who have the condition that they could prepay the loan without any prepayment charges, can switch over to the new benchmark-linked loan without having to pay anything extra except for a nominal legal or administrative cost. Even these legal or administrative costs have been waived by certain banks but there are other banks that are charging as much as Rs.10,000 for these fees. A lot depends on the bank that you have already taken a loan from. So, while there is no migratory fee as such to shift your loan from the old to the new rate, this fee has to be factored in. It would be best to do a cost benefit analysis to figure out if paying the fee is worth the reduction in EMIs that you will have if you do migrate to the new rates. If you feel that there will be a substantial savings that makes paying the new fees worth it, then it would be a good idea to do so. You could also try to negotiate with your bank regarding waiving off the legal and administrative fees, especially if you have been a longstanding customer of the bank.
What you need to Keep in Mind
One of the most overlooked points to keep in mind is that, although you can shift from the MCLR-based home loan system to a repo-rate linked home loan system, you cannot reverse this in future. Once you have chosen to migrate to the repo rate, you will not be able to choose the MCLR rate in future, for any reason, as the old system will not be in existence anymore.
Advantages of Repo Rate System
One of the biggest advantages of choosing a loan that has interest rates linked to the repo rate is that there will be greater transparency in interest rates when there is cut or hike in basis points by the RBI. This is because banks will be forced to pass on these changes to customers. In the earlier system, banks need to have passed on any cut in interest rates by the RBI to the customer. It did not percolate down to the end user. However, with repo rates, even the slightest decrease in basis points will be reflected by a cut in the interest rates, resulting in lower EMIs, especially because these are floating rate loans.
However, banks are free to levy a spread of their choice over the repo rate. There will also be a risk premium that is levied depending on the risk factors of the customer. This will vary from bank to bank. With BankBazar you can check current home loan interest rate
Your Interest Rate
How is your interest rate actually calculated from now on? It will be the repo rate + credit risk premium + (operating cost + negative carryon CRR). Of these, the operating cost can be modified once in 3 years. Your credit risk premium will be affected only if there is a very significant change in your credit risk assessment over the years. This will be according to the terms and conditions of your loan contract.
Once you know all this, you will be able to benefit better from these developments.
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