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Housing Insight

MCLR vs Base Rate

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Aakash Jain

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Understanding how your loan interest rates work is crucial for saving money and making smart financial decisions. Two important terms that you need to know are MCLR (Marginal Cost of Funds Based Lending Rate) vs base rate.

Each plays a major role in how banks decide the rates you pay. If you do not understand the difference, you might miss out on better options for your home loan. By learning about MCLR, base rate, and how they compare, you can take control of your financial choices and avoid paying more than necessary.

MCLR Meaning

When you take a loan from a bank, the interest rate you pay is closely linked to the MCLR. MCLR stands for Marginal Cost of Funds Based Lending Rate. It is the lowest rate at which banks are allowed to lend money to you, except in special cases. 

Introduced by the Reserve Bank of India (RBI) in April 2016, MCLR ensures that loan interest rates respond faster to changes in market conditions. This means you can benefit more quickly if the RBI cuts rates, helping you save on borrowing costs.

Example

Imagine the RBI lowers rates to boost the economy. Under the older system, banks could delay passing on the benefits. But with MCLR, banks must update their loan rates more regularly. So if you have a home loan linked to MCLR, your monthly payments could reduce sooner, saving you money.

Key Factors That Determine MCLR Rates

Here are the important factors that banks consider when setting their MCLR rates:

  • The cost banks incur to raise fresh funds through deposits and borrowings

  • The operating expenses needed to run the bank’s day-to-day business

  • The tenure premium, where longer loan periods usually come with higher interest rates

  • The repo rate set by the Reserve Bank of India, which influences how much it costs banks to borrow money

  • The marginal cost of funds, meaning the latest cost the bank faces to raise new money, not old costs

  • The required profit margin that banks add to ensure they make a reasonable return

Base Rate Meaning

Before MCLR was introduced, banks used the base rate system to decide loan interest rates. The base rate meaning refers to the minimum interest rate that a bank could offer you for any loan, ensuring fairness and transparency. 

Banks could not lend money below the base rate except in special cases approved by the Reserve Bank of India (RBI). The base rate system started in July 2010 and was designed to make sure that banks did not give loans at extremely low rates to select customers while charging higher rates to others.

Example

Suppose a bank’s base rate is 9%. If you apply for a personal loan, the bank cannot offer you a loan at 8% interest. They must offer you 9% or higher, unless it is a special loan type approved by RBI rules. This system was meant to treat all customers fairly and avoid hidden deals.

Key Factors That Determine Base Rates

Here are the key factors considered by banks when setting the base rate for loans:

  • The cost banks face when raising money through deposits or borrowing from other sources

  • The operating expenses involved in running the bank’s branches, staff, technology, and services

  • The profit margins that banks add to ensure they make a reasonable and sustainable profit

  • The regulatory requirements and rules set by the Reserve Bank of India (RBI) that banks must follow

  • The cost of maintaining cash reserves with the RBI, known as the Cash Reserve Ratio (CRR)

  • The overall risk profile of the bank, which may influence how cautiously or aggressively it sets rates

Differences Between Base Rate and MCLR

Choosing between loans linked to the base rate and MCLR is crucial because it affects how much interest you pay over time. Understanding their differences can help you make a smarter financial decision. Here is a clear comparison:

Features

Base Rate

MCLR

Meaning

Minimum lending rate used by banks before April 2016

Minimum lending rate set by banks after April 2016

Basis of Calculation

Average cost of funds, CRR, SLR, and operating costs

Marginal cost of funds, CRR, tenure premium, and costs

Response to RBI Changes

Slow adjustment to repo rate changes

Quick adjustment linked directly to repo rate movements

Consideration of Tenure

Same rate regardless of loan tenure

Higher rates for longer tenures due to added risk

Revision Frequency

Reviewed quarterly

Reviewed monthly

Transparency

Less transparent, flexible methods allowed

More transparent, follows RBI's structured formula

Impact on Borrowers

Delayed benefits from falling interest rates

Faster benefits from falling interest rates

Should You Switch Your Home Loan from Base Rate to MCLR

If your home loan is still linked to the base rate, you could be paying a higher interest rate than necessary. The base rate system reacts slowly to market changes, while loans linked to MCLR adjust faster. This means you could enjoy lower EMIs sooner when rates fall.

Switching to MCLR can reduce your loan interest costs, but you must first compare your current rate with the MCLR rate offered. If the difference is large enough, switching can lead to meaningful savings. You should also check the conversion fee charged by your bank and ensure that the savings outweigh this cost.

However, if market rates rise, loans linked to MCLR may see quicker increases in EMI compared to base rate loans. If you have many years left to repay your loan, switching usually makes financial sense. If only a few years remain, the benefit may not be significant after paying the conversion charges.

How to Switch Your Base Rate Home Loan to MCLR

Switching from base rate to MCLR is easy if you follow simple steps. Here is how you can do it:

  1. Contact your bank and request a switch

  2. Fill out the necessary forms and submit them

  3. Pay the applicable conversion fee

  4. Obtain a confirmation letter from the bank

Switching Costs to Consider

Here are the key costs that must be reviewed carefully before deciding to switch a home loan from base rate to MCLR:

  • Conversion fees that the bank charges for moving your loan to MCLR

  • Administrative charges for handling and processing the switch

  • Processing fees for updating loan documents and agreements

  • Possible changes to your loan’s terms and repayment conditions

  • Additional GST or service tax that may apply to the fees you pay

  • Prepayment charges if you decide to refinance your loan with another bank instead of switching internally

FAQs on Base Rate vs MCLR

What does MCLR stand for?

MCLR stands for Marginal Cost of Funds Based Lending Rate. It is the minimum rate below which banks cannot lend, except under certain conditions allowed by the Reserve Bank of India. Introduced in April 2016, MCLR ensures that changes in borrowing costs are passed on to borrowers faster.

MCLR is calculated based on the marginal cost of funds, operating costs, tenure premium, and the cost of maintaining cash reserves. It reflects a bank’s latest cost of raising funds. This structure makes MCLR more dynamic and responsive to market changes compared to older methods like the base rate.

Each bank decides its base rate following guidelines from the Reserve Bank of India. The calculation includes factors like average cost of funds, operational expenses, and a minimum required profit margin. Although RBI sets the framework, banks retain the responsibility to set their individual rates.

MCLR is generally better because it adjusts faster to market rate changes. Borrowers with MCLR-linked loans experience quicker EMI reductions after RBI policy cuts compared to those with base rate loans.

MCLR and base rate act as minimum lending rates. When either rate changes, the interest charged on loans changes too. MCLR responds faster, providing quicker financial relief compared to the base rate.

Yes, MCLR directly impacts home loans with floating rates. When a bank’s MCLR reduces, the home loan rates linked to it usually decrease too, resulting in lower monthly EMIs for borrowers.

Yes, loans linked to the base rate are directly affected by any changes in it. An increase in the base rate can raise your EMI, while a decrease can lower it.

MCLR is set internally by banks based on their funding costs. The repo rate is set by RBI and is the rate at which banks borrow short-term funds. Repo rate changes influence, but do not directly decide, MCLR.

The base rate is the minimum rate banks charge borrowers, based on their internal costs. The repo rate is the RBI’s lending rate to banks, affecting overall market liquidity and funding costs indirectly.

MCLR is linked to a bank’s internal cost of funds, while EBLR (External Benchmark Linked Rate) is tied directly to external benchmarks like the RBI repo rate or government bond yields.

The Reserve Bank of India does not directly set the MCLR. It only provides a framework for banks to calculate MCLR based on marginal funding costs, operational expenses, and risk margins.

MCLR replaced the base rate to improve the speed and fairness of interest rate transmission. It links loan rates more closely to banks' current borrowing costs, benefiting borrowers faster after policy cuts.

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Hi! I’m Aakash Jain
Blogger

Aakash is a seasoned marketing and finance professional with over five years of experience. With a unique blend of financial expertise and creative flair, he excels in crafting succinct, user-friendly content that empowers readers to make well-informed choices. Specialising in articles, blogs, and website pages for loan products, Aakash is dedicated to simplifying complex concepts and delivering valuable insights that resonate with diverse audiences.

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