Since October 1, 2019, all retail lending by banks is based on external benchmarks for which most banks have opted for repo rate.
Home Loan: According to some reports, SBI home loans may be available with the 6-month reset date to the borrowers. Currently, the home loan linked to the bank’s MCLR has a re-set period of 12 months. This means any revision in the repo rate by the RBI gets transmitted to the borrower after a waiting period of 12 months. Importantly, a few other banks like Axis Bank, Kotak Bank and ICICI Bank already have Marginal cost of funds-based lending rate (MCLR) home loans with a reset-period of 6 months.
The 6-month SBI home loan will be applicable only for those borrowers who still have loans linked to MCLR. The actual modalities remain to be seen as and when the bank starts offering it. The MCLR loans are loans taken between April 2016 and September 30, 2019. Since October 1, 2019, all lendings by banks are based on external benchmarks for which most banks have chosen the repo rate. So, new loans are mostly RLLR – Repo Linked Lending Rate. One is allowed to switch from MCLR to the RLLR mechanism with the same bank or any other bank.
But, is it better to opt for a 6-month reset period in an MCLR-based home loan?
The answer to this is not as straight forward as it looks. In a falling interest rate scenario, the shorter reset period of 6 months will suit. However, when rates start to climb, the immediate transmission will hurt the borrowers and the EMI will go up quickly.
The home loan borrowers look forward to fall in their EMIs as and when the general interest rate in the economy falls. However, this may not be the case always. For those who have taken home loans after April 2016, the rate of interest is linked to the bank’s MCLR. If MCLR loans are not switched to the existing mechanism of external benchmark rate (EBR), those borrowers will see a delayed transmission of rate cuts.
How it impacts
Let us assume, you have a home loan with a 12-month reset clause since July 2017. Now, if the RBI cuts repo rate in August 2020, the bank’s MCLR in August will fall. However, for the borrower, there won’t be any immediate impact. The impact will be seen as per the MCLR of the bank in July 2021.
But, if the loan had been on 6-month reset clause, the impact will be seen as per the MCLR of the bank in January 2021 i.e. every six-months in July and January.
Effectively, there is a waiting period for the MCLR based home borrowers to see an impact on the EMI’s or the tenure of the loan. In other words, MCLR based home loans can be called ‘fixed’ loans even though they are based on ‘floating’ rates.
It is practically impossible to predict the long term movement of interest rates. And, as home loans are long term in nature, it is better to provide the option of changing reset period to the borrowers, after paying a certain fee, if required. Without the option to change reset-period, the rising interest rate scenario will hurt the borrowers as EMI’s may see a sharp rise.