If you have a home loan, you would have at some point received a message from your bank that interest rate on your home loan has been reduced. As a result, either your Equated Monthly Installment (EMI) is lesser or tenure is reduced with EMI remaining same. No matter how small the reduction, this is cause for some joy. So if you hear of a bigger cut effected by another bank, you will definitely contemplate a home loan balance transfer. Before you take a decision, first understand why the rate revisions happen.
Any increase or decrease in your home loan rate is possible only when the Reserve Bank of India (RBI) adjusts the reverse purchase (repo) rate and banks, in turn, adjust their internal benchmark interest rate. Repo is the rate at which the central bank of a country lends money to commercial banks against the pledge of government securities. Banks pledge them to secure funds to meet their day to day business. The internal benchmark used by banks to determine interest rates of home loan is the marginal cost of (funds-based) lending rate (MCLR).
The RBI has cut the repo rate in February, 2019 to 6.25% from 6.50%, by 25 basis points (bps). One bps is one 100th of a percentage point while MCLR is the lowest possible interest rate charged for a home loan.
Cost of Credit
The interest you pay on your home loan is the cost of credit. For your bank, the repo rate is the cost of credit from RBI. Banks enter into an agreement with the RBI to repurchase the same pledged government securities at a future date at a pre-determined price. RBI manages this repo rate to control inflation.
Since 2016, the effective rate of interest on home loans have been linked to the MCLR which is linked to various factors like fixed deposits interest rates, the source of funds, savings rate, credit to deposit ratio and the spread of the bank. The borrower’s eligibility also impacts home loan rates. You can learn how on Finserv MARKETS.
Not all banks respond with an MCLR cut following a repo rate cut. Those that do, may do it a good one month down the line and those who do it earlier entice you to make a home loan balance transfer. Rarely do banks match the repo cut, but let us assume they do in the table below.
Home Loan Balance Transfer
The question is, should you jump at such offers? You should first make a cost-benefit analysis in terms of:
- Charges being levied like processing fee, documentation, stamp duty; and waivers offered.
- Delayed transmission of the rate cut. While RBI announced the cut in February, banks are only now announcing cuts.
- Poor transmission of the rate cut. While RBI cut repo rate by 25 bps, banks are reducing MCLR by only 5-10 bps.
Experts say the reduction should be by at least 50 bps, to make a home loan balance transfer. While any reduction in total interest repayment is a blessing, you should calculate it as a percentage of the loan amount.
The savings generated from the home loan balance transfer should cover a possible interest rate hike in the future as well. A similar comparison should be done even for longer tenure home loan balance transfer amount, over the original tenure.
External Bench marking Soon
The RBI has announced that from April 1, 2019, a new floating rate home loans for commercial banks should be bench marked with an external benchmark such as:
- RBI policy repo rate, or
- Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or
- Government of India 182 days Treasury Bill yield produced by the FBIL, or
- Any other benchmark market interest rate produced by the FBIL
Most banks have chosen the repo rate. This is expected to bring in standardization and transparency in loan pricing.
“The spread over the benchmark rate — to be decided wholly at banks’ discretion at the inception of the loan — should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract,” the RBI has said.
Final Analysis: It may be better to hold on to home loan balance transfers until the new lending regime for floating rate home loans comes into effect. The new Monetary Policy may also bring some rate cuts.
- Immediate transmission of the repo rate cuts
- A fixed interest rate and spread value decided by your bank
- Uniform benchmarks within a loan category
- Comparison between loan rates of different banks
Even if you have a loan from a housing finance company which does not follow such repo-linked interest rate adjustments, you can still negotiate better rates with the threat of a home loan balance transfer to banks. Online portals such as Finserv MARKETS are a great place to begin your research and purchase journey.
Also read ways to reduce your home loan only at Finserv MARKETS.
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