While THE Reserve Bank of India (RBI) has kept the repo rate unchanged at 6.5% since April last year, banks are increasing their marginal cost of fund-based lending rate (MCLR) because of rising costs of funds. For borrowers with home loans linked to MCLR, this translates into higher equated monthly instalments (EMIs). Switching to repo-linked loan rate (RLLR) for home loans will be a better choice now as the repo rate is likely to remain stable or even decrease, say experts.
By switching to RLLR, a borrower can save on substantial interest costs. Also, switching to an RLLR linked home loan can be a better choice if a borrower lacks extra funds to repay the mortgage. The transmission of interest rate changes will be faster in RLLR, especially when rates fall, as compared to MCLR. This is also transparent and easy to track by borrowers whenever rate changes take place. Before switching borrowers should factor in the costs associated such as processing fee of 0.5% of the outstanding balance, mortgage registration at 1% of the loan amount, valuation and the title clearance fees.
The frequency of MCLR reset is determined by the lender as per the loan’s terms and conditions. Chaitali Dutta, founder, AZUKE Personal Finance Advisory, says it is anticipated that the RBI will soon begin to reduce the repo rate. “In such a scenario, transitioning to a repo rate-linked home loan could be advantageous,” she says.
RLLR more transparent
State Bank of India, the country’s largest lender, has increased the 3-year MCLR from 8.75% in July last year to 9.1% now. In fact, in the last three months, the lender has raised the rates three times. Other state-owned banks such as Bank of Baroda, Punjab National Bank, UCO Bank have also raised their MCLRs. Even private sector banks such as HDFC Bank and Yes Bank have raised their key lending rates. MCLR was introduced by the RBI in 2016.
Since 2019, banks are offering loans linked to RLLR to all new borrowers. For example, if a bank has set repo rate as the benchmark for setting its lending rate, it can change its RLLR only when the RBI increases or decreases the repo rate. The changes are quickly reflected in the interest rates of these loans. And this transparency ensures that borrowers benefit directly from rate cuts and are aware of the reasons behind rate hikes.
Repo rate-linked loans often start with a lower interest rate compared to MCLR-based loans. In fact, the share of MCLR-linked loans had come down to 38.5% by
March this year from 46.5% in June 2022. Adhil Shetty, CEO, Bankbazaar.com, says when the repo rate is low, these loans become significantly cheaper, making them attractive to borrowers who wish to reduce their monthly EMI burden. “When RBI reduces the repo rate, borrowers of repo rate-linked loans benefit through lower EMIs or a reduced loan tenure,” he adds.
However, the changes in the policy rates are not the sole factor influencing the MCLR. Banks also factor in their marginal cost of funds, operating costs, tenure premium, etc., while determining their MCLR. “These factors lead to a lag in the transmission of policy rate changes to the banks’ MCLRs as compared to their EBLRs,” says Ratan Chaudhary, head, Home Loans Business, Paisabazaar.
Banks may increase spread for RLLR
While the repo rate is set by the RBI, banks can adjust the spread they add to the repo rate when determining the RLLR. As the cost of funds rises due to a higher repo rate, banks may increase this spread to maintain profitability, effectively raising the RLLR for new loans. “Although banks are under competitive pressure to offer attractive rates to retain existing borrowers and attract new customers, the rising cost of funds might push them to adjust the spread depending on the market situation and cost of funding in future,” says Shetty.