Increase in Interest Rate: How MCLR hike impacts retail borrowers

Shell out more EMI for home loan or convert your loan to a cheaper repo rate linked lending rate

Even auto and personal loans will become more expensive.
Even auto and personal loans will become more expensive.

With the country’s largest lender, State Bank of India, increasing its marginal cost of funds-based lending rate (MCLR) by 10 basis points (bps) to 7.1% after three years, and other lenders such as Axis Bank, Bank of Baroda and Kotak Mahindra Bank too increasing their MCLR rate by 5 bps, existing retail borrowers whose loans are linked to MCLR will now have to pay higher equated monthly instalments (EMI) for their home loan when the reset date comes around. Even auto and personal loans will become more expensive.

The turn of the rate cycle will affect borrowers whose loans are linked to an external benchmark like the repo rate or the three-month or six-month treasury bill rate once the Reserve Bank of India increases the policy repo rate, which could be very soon. In fact, RBI in its monetary policy review on April 8 has signalled that its focus is now shifting from reviving growth to reining in inflation. Since then, the yield on the benchmark 10-year government securities has remained above 7%. Kotak Institutional Equities expect the first repo rate hike of 25 bps in the June policy (earlier expectation was in August) and a cumulative hike of 100 bps in FY2023.

MCLR hike impact on retail loans
Assuming your MCLR-linked home loan for 20 years is priced at 7.35%, your per lakh interest is Rs 91,147 and your EMI is Rs 796. A 10 basis point increase in the MCLR will increase your EMI to Rs 803 and the loan interest to Rs 92,609. Rate changes are incremental. There could be several hikes through this year. If so, your interest rate will rise by much more than 10 basis points.

Adhil Shetty, CEO,, says if the borrower is on an MCLR loan with a substantial balance, he must check if it benefits him to remain on the loan. “Your rate hike date may still be several months away, and you can continue enjoying your current rate. Secondly, check the premium you’re paying over a repo loan. Repo loans are cheaper today. More than 20 lenders have their lowest rates at under 7%. If the difference is substantial – let’s say 50 basis points – it makes sense to refinance. You could request your bank for a conversion to repo, or move to another lender offering you better terms,” he says.

Loans linked to MCLR
The MCLR, which was introduced in 2016 by the central bank, is determined by the marginal cost for funds, especially by the deposit rate and by the repo rate. It is an internal benchmark that determines the interest rate on loans based on Cash Reserve Ratio, loan tenure and the operating costs. Any change in repo rate will also change the marginal cost and the MCLR would also change. Prior to that the central bank had introduced the base rate system to ensure that banks do not lend below a certain rate and that the changes in the policy rate are effectively transmitted to the borrower.

Prepay, balance transfer loans
Experts say with rate rising, it is better to do some part pre-payment of home loans to reduce the interest burden. Banks do not charge for partial or full repayment of the principal outstanding on floating rate loans if it is done from own funds. In fact, partial payment in the initial years of the loan tenure will help you reduce the overall interest payout. With frequent pre-payments when the interest rates are rising, you will not only reduce the principal outstanding, but also reduce the interest amount.

After repayment, keep the EMI the same or increase it. A lower tenure will reduce the interest payout in the long run. If you feel that the bank is charging a higher interest rate, then you can opt for a balance transfer of the outstanding loan to another bank at a lower interest rate. However, check the associated costs for the balance transfer before deciding on it.

Heavier burden
Existing retail home loans linked to MCLR will now have higher EMIs when the reset date comes around.
Even auto and personal loans will become more expensive.
You can opt for a balance transfer of the outstanding loan to another bank but check fot the associated costs first.
Repo loans are cheaper today as many banks have interest rates below 7%.

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