Loans have been a cause of concern for most of the middle class and higher middle-class population due to the significantly higher real estate rates. The repo rates have reduced quite significantly in the past one year. However, the benefits of such reduction seem to reach the borrowers with a hair cut. Until demonetization, the loan rates have been hovering above 10% levels. However, now with the base rates reducing, with every rate cut, there is an additional benefit for the borrowers. Here’s how.
With demonetization, the overall deposits have increased significantly leading to an excess liquidity situation in the banking sector. This has compelled the banks to lower their lending rates across various tenors. Banks have been under immense stress in terms of the NIIs and NIM margins lately due to the sudden inflow of deposits. However, this seems to be a good news for the borrowers. Although, the corporates will still continue to be priced basis the overall indebtedness and may not be benefitted by the interest reduction. The individuals, on the other hand, will be immensely rewarded by the existing interest rate regime.
Currently, the interest rates are pegged to something called as a base rate. Now the base rate does change with the repo rate, but the change is reflected with a lag of at least 6 months despite the RBI’s efforts in increasing the overall monetary policy transmission. RBI has now announced that the banks shall move from a base rate system of cost of funds to something called as MCLR (which is affected by the repo rate movement as well as the deposits). What must the borrower do?
- Check the outstanding and the tenor of the loan. If the outstanding is less than Rs 5 lacs or the loan tenor is less than 3 years then one should not shift to the MCLR regime. If only otherwise, then one should shift to MCLR regime at the earliest looking at the downward bias of the repo rates.
- Contact your bank and ask them to link your home loan rate with MCLR instead of the base rate. The customer will have to pay a one-time charge of 0.5% of the total outstanding amount of the loan or one can get it done for free on the date of the anniversary of the loan.
- From there on, one will have two options, EMI reduction or tenor reduction. It is always advisable to choose the latter.
Why is it so important to align your rates with MCLR? As we know, the RBI has reduced the repo rate by almost 150 bps in the past fiscal year. The benefit given to the borrower of the reduction is in the range of 25-35 bps on the base rate, whereas the benefit if shifted to MCLR is up to 90 bps which would save almost 2 lacs over a total outstanding of Rs 50 lacs over the entire tenor. Hope that helps in understanding the rationale to shift the paradigm from base rate to MCLR. Demand for the MCLR linked loans, the transparency is way higher than the base rate ones.
Below is a quick understanding of the amount of savings one can make by shifting the loans to MCLR.
Another benefit of shifting to MCLR interest regime is with every rate cut the eligibility limit of the borrower increases significantly, especially for the ones where residual tenor is 10 + years. A borrower earning Rs 1 lac a month is eligible for Rs 55 lacs of home loan for 20 years. The same individual can now get a 60 lacs loan for the same tenor. The eligibility limits increases to Rs 62 lacs for a 25-year loan tenor. Although the pricing of the loan is subject to the customer’s overall risk grading, one can definitely shift to the MCLR pricing owing to the downward bias of the interest rates.
One must always keep in mind, if the EMI is reduced, then one gets equated benefits over the months, whereas if the tenor is reduced instead of the EMI then the benefits are received by the end of the tenor which would essentially will be lump- sum and most definitely higher than the former approach. However, you should take a call basis the current cash positions and appetite to bear the EMI amount.
Thank you. 🙂