Are you Taking Advantage of the New Home Loan Interest Rate Cuts?
Unlike the past, when Home Loan rates hovered around 12 % to 13%, recent times have seen a fall in Home Loan Interest Rates. This has enabled many a home purchase. In fact, this fall has received a further impetus after the PM’s year end speech, which resulted in banks cutting the lending rates by as much as 90 basis points. (1 Basis Point=1/100th of Percentage Point)
With effect from April 2016, on any New Home Loan, the lending rate would be based on MCLR, which stands for Marginal Cost of Funds based Lending Rate.
What is MCLR
Replacing the Base Rate system, MCLR has been introduced to pass on the benefit of rate cuts, offered by the RBI, to the borrowers. MCLR is a tenor-based benchmark, and banks have to publish the MCLR for varying durations—from overnight to three years.
When the interest cycle is showing a downward trend, a loan based on MCLR will be to the borrower’s benefit.
One of the factors that brings a reduction in MCLR is the repo rate. This is the rate at which banks borrow funds from the RBI. A fall in the repo rate has a direct impact on the MCLR. But, are the borrowers beneficiaries to these rate cuts? Does it bring down your Home Loan EMI?
As a borrower, you get only the partial benefit of the rate cut. This is because banks add a “spread” to the MCLR, which becomes the Home Loan Interest rate that you pay on the housing loan.
What is ‘Spread’?
Spread is the difference between the MCLR and the rate at which the Home Loan is given to the borrower. The markup on the MCLR can be a flat spread or a rate that varies according to your CIBIL Score. This score reflects your creditworthiness: the higher your credit score, the better placed you are to bargain for a lower interest rate.
If you enjoy a credit score of over 760, there will be a lower spread or a nil spread on your Home Loan. While the MCLR is reset at 6 months or one year, the spread does not change. A higher spread only gets added up into your borrowing costs.
The Heart of the Matter: MCLR and Home Loans
Home Loans have a long tenor, typically 10-25 years. When you take a floating rate Home Loan, your loan will be linked to the MCLR. The 6 month MCLR or the 12 month MCLR will be set as the benchmark rate. Hence, all floating rate Home Loan agreements will have a reset clause at a pre-specified interval.
A point worth noting here—though the MCLR changes monthly, the change is not immediate. It will be effective only from the reset date. Post the reset date, whatever the change in MCLR, the Home Loan will be adjusted to this new rate.
To cite an example; if you’ve taken a Home Loan at 8.25% one year, MCLR and the spread is 50 basis points, you will have to pay 8.75% on your Home Loan. For the next one year, your Home Loan repayment will be set at 8.75%. However, if there’s a fall in spread by 25 basis points, and the one year MCLR is revised to 8.00%, repayments will be at 8.25%.
When you take a Home Loan, you have to consider the interest plus the spread and other loan processing charges to arrive at the cost of loan.
MCLR is the new kid in the block. It needs to be seen if it serves the intent of the RBI to pass on the rate cuts to customers.