RBI (Reserve Bank of India) has launched a new repo rate linked home loans. This scheme could provide people cheaper and more transparent loans to buy a home. But on the other hand, there exists a downside risk for the same. Your monthly installments increase as the repo rate is sustainably increased.
SBI (State Bank of India) is India’s largest lender, introduced this repo-rate linked home loans first. The inauguration date of this in the market was on 1st July. Banks such as Syndicate Bank, Bank of India, Union Bank and Allahabad Bank have also joined hands with the central bank’s repo-rate linked home loan scheme.
MCLR –based loans
Normal home loan interests are calculated, taking the base as the marginal cost of funds-based lending rates (MCLR). This is the internal reference rate set by the individual banks.
The rate of interest charged is nominally based on RBI’s repo rate (rate of interest charged by the central bank itself). However, the calculation of MCLR by each bank is complicated.
The MCLR varies from bank to bank and is influenced by various factors. One of them is the risk assigned to the loan taker. This is the reason why transmission to the borrower was not successful.
The customers had a complaint that under MCLR and the base rate regime, they were cut from the benefits of the policy. Although an increase in the interest rate was the foremost information send to them by the banks.
For the satisfaction of the users, RBI then after four actions bought some changes. The repo rate was cut by 110 basis points, where earlier only 29 basis points were cut to the users by the banks. Therefore, repo rate-linked home loans speed up the process of transmission. From this, end users can easily avail of the benefit of RBI’s actions. The interest in the repo rate-linked loans is based on the repo rate. It is not repo rate itself.
For example- In SBI, the base spread is 2.25 % points over the repo rate. During the launch of the product, the repo rate was 5.75%. This would lead to an effective RLLR (repo-linked lending rate) of 8%.
According to the risk assigned to the borrower, the bank will add a risk-based spread of 40-55 basis points. After this, the effective interest rate would be 8.4 to 8.55%, whereas MCLR ranges from 8.55% to 9.10%. The RLLR would be further lowered as the RBI has cut the repo rate by 35 basis points, most recently.
It is believed to have brought more transparency with the introduction of the repo-linked rate. A home-loan borrower will know the interest rate and all about the spread.
However, there is a misapprehension among consumers that repo rate-linked products would be useful as the loan’s interest rate will constantly change, just like the repo rate itself. But on the contrary, borrowers make their payments more difficult. They all opt for floating-rate loans rather than fixed-rate once.
Most people go for a floating rate, thinking that the vagaries of the rates are always going down or hardening. Although, there are some risks involved for the borrower as the central bank can raise the repo-rate eventually. This will increase the interest rate on loans and the installment amount.
It is vital to understand that in the repo rate-linked loans, the changes are frequent, and thus installment amount changes simultaneously on uncertain and unexpected notice. Earlier with the increase in the interest rate, the tenure of the loan was also used to increase. It was done in rare cases when the installments were adjusted.
Suppose a borrower takes a loan of Rs. 50 lakhs for 10 years. And the prevalent repo rate is 5.4%. The effective interest charge will be of 8.05%. The monthly installment would amount to Rs. 60,796. After three months, RBI changes the rate by 25 basis points. Moreover, the interest rate becomes 8.3%.
Now, keeping the tenure constant, the installment will be Rs. 61,445. On a similar note, the rate is cut short to 25 basis points, and the installment will be of Rs. 60,151.
Therefore, the repo rate-linked loans are both beneficiary and harmful depending upon the rate of change by the central bank, i.e., RBI.