Most home loan borrowers when availing mortgage consider only the interest rate offered by various banks. This becomes the main deciding factor. However, apart from the home loan interest rate, there are many other external benchmarks that will affect your home loan EMI especially if you choose a floating rate home loan. Before availing a home loan, you will have to compare various factors to make sure you are getting a good deal which will help you save in the longer run.
How do banks calculate interest on floating rate home loans?
In a fixed rate home loan, the interest rate is fixed and does not change during the tenure of the loan. However, when it comes to floating rate home loans, the interest payable varies throughout the tenure of the loan. There are many external benchmarks that has an impact on floating rate home loans.
Banks follow the Marginal Cost of Funds Based Lending Rate (MCLR) to calculate interest on your home loan. Under the MCLR system, banks are required to calculate and announce the MCLR on a monthly basis for various loan tenures such as overnight, one month, six months, one year, etc. The MCLR set by the bank will reflect the bank’s cost to own and operate the funds. You home loan interest rate and amount payable will be affected every time the bank changes its MCLR.
What is a repo rate?
One of the main external benchmarks that will affect your floating rate home loan going forward is the repo rate. What is a repo rate? A repo rate refers to the rate at which Reserve Bank of India (RBI) lends money to commercial banks in case of shortage of funds. Repo rates help the RBI to control inflation in the country. In simpler terms, when you borrow cash from a bank, you will be required to pay an interest rate on the principal amount borrower. Similarly, when banks face a financial crisis and have a shortfall in funds and borrow from the RBI, they will be required to pay interest as well. This interest rate charged by RBI to lend funds is called a repo rate.
Repo rate cut and its effect on floating rate home loans
In the last Monetary Policy Committee (MPC) held in February 2019, the Reserve Bank of India cut the repo rate by 25 basis points. The current repo rate stands at 6.25%. Many home loan borrowers rejoiced over this news as their EMIs will go down. However, this joy could be short-lived as the EMIs will not go down immediately.
Though the RBI’s repo rate plays a crucial role in determining the bank’s Marginal Cost of Funds Based Lending Rate (MCLR), it need not necessarily bring the MCLR down. The reason being, your home loan EMI is affected by a lot of factors such as the lender’s MCLR, the reset date, and the mark-up.
Top external benchmarks that will affect your home loan
The top three factors that determine your home loan EMI are as follows:
- The bank’s MCLR: Under the MCLR system, banks are required to calculate and announce the MCLR on a monthly basis for various loan tenures such as overnight, one month, six months, one year, etc. The MCLR set by the bank will reflect the bank’s cost to own and operate the funds. If you have a home loan, it is wise to not an expect immediate reduction in your EMI amount as a reduction in repo rate will not have a significant impact on the bank’s MCLR. However, if you are planning on availing a home loan on or after April 2019, you may be benefitted from the repo rate cuts as the banks are now asked to sync their floating rate of interest to external benchmarks such as repo rates.
- Mark-up: As banks are not allowed to lend above the fixed MCLR, they usually charge a mark-up which will be over and above the MCLR charged. A Mark-up fee can go up to 30 basis points. For example, a bank’s MCLR can be 8.55% and the mark-up fee can be 25 basis points. In this case, you will land up paying both the MCLR and the mark-up fee. If you are planning on applying for a home loan, make sure you calculate and compare both the MCLR and mark-up fee charged by various banks before choosing one.
- MCLR reset date: Your home loan EMI does not change every time RBI announces a rate cut. Under the MCLR system, the reset-date is the date when your home loan interest date will be reset based on the MCLRT prevailing on that specific date. The interest rate on all MCLR based flexible home is fixed for a year. Therefore, if you avail a home loan in January 2018, your MCLR and EMI amount will remain constant for a year even if the bank reduces their MCLR during the long tenure. This way, rate cuts will not have any impact on your EMI.
How to reap the benefits under floating rate home loans?
Though the chances of your mortgage payments reducing after a rate cut are very slim, there are certain things you can do to reduce the EMI burden. Some of the steps you can take are:
- If you have a home loan under the base rate system, consider changing it to an MCLR-based loan to reap the benefits. It is not recommended to shift from a based rate home loan to MCLR-based loan if your maturity date is nearby.
- If you are paying a high interest rate on your home loan (More than 10%), it is recommended to get your loan re-financed. Check out interest rates offered by other banks and request your existing lender to reduce the interest rate charged. If your lender does not agree to do so, consider a home loan balance transfer. A low interest rate will help you save several lakhs i9n the longer run.
- If you are planning on applying for a home loan in the future, compare rates offered by various banks before you choose one. Make sure you compare the MCLR, mark-up, and other charges before deciding.
- Check if you are eligible to receive credit-linked interest subsidy under the Pradhan Mantri Awas Yojana. This scheme is valid until March 2019.
As mentioned earlier, it is very important to research the best home loans available in the market before you apply for one. You can compare various home loans on neutral financial advisory websites like BankBazaar.
