You may want to shift to an RLLR loan from a BLR or an MCLR loan to benefit from lower EMIs whenever the RBI reduces the repo rate after factoring in the loan transfer charges, especially if you’re moving from one bank to another.
Many of you must be aware that the Reserve Bank of India has directed banks to implement as many as three lending systems in the last ten years. While it introduced the Base Lending Rate (BLR) system in 2010, it moved to a Marginal Cost of Funds-based Lending Rate (MCLR) system in 2016, and in October 2019, it further introduced the External Benchmark-Linked Lending Rate (EBLR) regime. If you’re wondering why so, it is because the RBI wants the banks’ lending systems to be more transparent and better aligned with the prevailing economic conditions.
This is extremely important as even a little fluctuation in the loan interest rates could make a huge difference to the borrower, especially when he’s servicing a long-term loan like a home loan. For example, if you’re servicing a Rs 50 lakh home loan with a 20-year tenure, a mere 1% reduction in your loan interest rate from 8% to 7% could not just bring down your EMIs from Rs 41,822 to Rs 38,765 but could also reduce your overall interest burden by Rs 7.3 lakh. I’ve discussed a few pointers to help you make informed decisions about shifting your loan regime.
The transition from BLR to MCLR to EBLR interest structure
Under the BLR system, the banks set the lending rate while considering its average cost of funds. In the MCLR system, the loan rates are calculated on the basis of the marginal cost of funds. However, the BLR and the MCLR systems still did not solve the problem of low rate cut transmissions to the borrowers whenever the RBI decided to cut the repo rate. Under the EBLR system, the RBI directed the banks to peg their floating rate loans to any of the recommended external benchmarks including the repo rate in addition to asking them to reset their lending rates at least once every three months. Borrowers who have taken or shifted to a repo-linked loan, also called a Repo-Linked Lending Rate (RLLR) loan, have seen a quick revision in their loan interest rates equal to the changes in the repo rate mandated by the RBI since October.
BLR or MCLR-linked loans have also become cheaper but at a much slower pace in comparison. In the MCLR regime, banks usually link their home loans to their six-months or one-year MCLR rates; therefore, their loan interest rates are readjusted in the frequency of a six-month to one-year period. Now suppose the RBI cuts the repo rate but decides to hike it again within the MCLR reset period, the borrower might not observe any change in his loan interest rate. On the other hand, banks have to reset their loan rates at least once in a three-month period under the EBLR system. In fact, while some banks reset their interest rates immediately whenever the RBI changes the repo rate, others do so on a fixed date every month or at a regular interval. Therefore, home loan borrowers get almost an immediate benefit from the RBI’s repo rate reduction.
So, should you move to an RLLR loan from a BLR or MCLR loan?
You may want to shift to an RLLR loan from a BLR or an MCLR loan to benefit from lower EMIs whenever the RBI reduces the repo rate after factoring in the loan transfer charges, especially if you’re moving from one bank to another. Doing so could result in not just reduced EMIs but could also cut down your overall loan burden, decrease the number of EMIs payable, and help you become debt-free faster. This might appear to be a great move in the present times when the RBI has reduced the repo rate by 225 basis points to the current 4% from 6.25% in February 2019. However, you must also realise that your loan interest rates will increase whenever the RBI hikes the repo rate in the future.
The other critical consideration before initiating a loan regime shift should be your credit score. The RLLR loan rates are typically calculated after factoring in the repo rate + bank’s margin + borrower’s risk spread. Now, if you have a stellar credit score (usually above 750), your bank might not charge the risk spread from you resulting in lower interest rates and EMIs. Meaning, if you’ve been servicing a BLR or an MCLR loan and your credit score is poor, you might end up paying a higher interest rate if you move to an RLLR loan because of the risk spread. As such, you must check your credit score and take corrective measures if your score is lower than 750 before finalising your decision.
Not just that, you’ll have to ensure your credit score remains high throughout the loan tenure as any dip could trigger an interest rate hike during the course of the RLLR loan tenure. You can do so by repaying all your loan EMIs and credit card dues in full on time, limiting your total credit card usage to 30% of their combined credit limit, avoiding multiple credit applications in quick succession and reporting any errors in your credit history to the issuing agency among other things.
In conclusion, you must check your credit score regularly and take immediate corrective measures to improve it if it’s low, regardless of whether you want to change your loan regime or not. A high credit score would allow you the best interest rates in whichever loan system you come under or choose. Also, it’s not necessary your bank will always have the best loan offers for you; so you must compare loan offers by different banks before reaching a final decision.
(The author is CEO, BankBazaar.com)