Why MCLR Linked Home Loans Fail to Reduce Your EMIs
14 Nov 2019
Every time the Reserve Bank of India (RBI) reduces the policy rates, some questions like “Will the benefits of rate cuts help or will the equated monthly installments (EMIs) reduce?” would pop up. The RBI has reduced the rates by 135 basis points during this year. One basis point is equivalent to one-hundredth of a percent.
However, financial institutions are often reluctant to pass on the rate cut benefits to their borrowers. Even if some institutions do reduce the rates, the decrease is very marginal. The RBI reduced rates by 35 basis points in August 2019.
What is MCLR?
MCLR is the marginal cost of funds based lending rates. MCLR-linked loans are the lowest-interest home loans offered by financial institutions. These interest rates are linked to the repo rates and cost of funds for the lenders. Therefore, any modification to the repo rate affects the home loan floating interest rates. In the case, the lender reduces the home loan MCLR rate, the home loan floating interest also decreases. However, it does not affect the EMI but the total loan duration reduces.
Having understood what MCLR is, bear in mind that the benefits in case of RBI rate reduction may not be immediately available. Does this mean the MCLR-linked loans are not beneficial? Here are some common myths associated with rate reductions and when and how these are passed on to the borrowers.
1. Interest rates are immediately reduced once the MCLR decreases
Even when the MCLR rates are reduced by the banks, MCLR-linked home loan borrowers may not immediately enjoy the benefits. This is primarily due to the reset clause included in the terms and conditions. This period varies from one lender to another and according to the RBI guidelines, the maximum reset period cannot exceed one year. This means that you need to wait for the reset period before the MCLR reduction benefit becomes available to you. The lenders include the reset period within the loan agreement.
A shorter reset period is advantageous when the repo rates are decreasing. It is recommended to choose a lender that offers a three-month reset period to enjoy the reductions quickly.
2. Housing finance companies (HFCs) also decrease the rates
Currently, MCLR is the applicable benchmark rate for banks. Most of the HFCs link the home loan rates to the retail prime lending rate (RPLR) or the benchmark prime lending rate (BPLR). Therefore, when banks announce interest rate reductions, most borrowers think that the HFCs will also reduce the home loan rates. However, HFCs may not decrease the rates as these are not linked to MCLR but either to the BPLR or RPLR.
Recently, during the Budget speech, the Indian Finance Minister Nirmala Sitharaman announced that the National Housing Bank (NHB) will not regulate the HFCs. Post this announcement, RBI said that HFCs would be considered as one of the categories within non-banking financial companies (NBFCs) for regulatory purposes. This means that HFCs will now be directly under the RBI guidelines. It is expected that MCLR may become the benchmark for HFCs, bringing more transparency and reducing confusion amongst borrowers.
3. Standard interest rates for all borrowers
A common perception among new and existing borrowers is that interest rates during the tenure remain the same for both categories. However, this is incorrect as several factors determine the MCLR and the applicable interest rate for a borrower. As the deposit interest rates are linked to economic factors, the cost of funds for the lenders varies. Therefore, there is a difference in the applicable rate of interest for new and existing borrowers. If you are an existing borrower, you need to wait for the reset period to be completed before the MCLR cut benefits become available for you.
4. Switching loans is advantageous
You may want to switch your existing home loan from an HFC to another institution. However, before you make this decision, you need to consider the operational issues and the effective savings. When you switch to a new lender, costs like franking charges and processing fees may be applicable. Moreover, you will have to visit the new lender multiple times and complete the necessary application and documentation. It is recommended to consider switching the loan only if the difference between the existing and potential rate of interest is at least 75 basis points. You must not make a hasty decision and only consider the actual benefits of such a switch. You can also read on if you are also eligible for PMAY subsidy on your home loan balance transfer. Get a home loan balance transfer at Finserv MARKETS and transfer your home loan balance with ease and enjoy amazing interest rates with minimal documentation.
If the loan tenure is nearing completion, switching to a new bank because the rate is lower due to the reduced MCLR rate may not actually give you huge savings. Before you make your decision to switch the home loan, it is important for you to negotiate with the new lender to get the most beneficial deal.
Lenders provide MCLR-linked finance only when the eligible for PMAY subsidy on your home loan balance transfer is availed at a floating interest rate. Any change in the MCLR does not affect the home loan availed at a fixed rate of interest. Current MCLR rates are seeing a downward movement and if you are contemplating buying a home, you may benefit by choosing MCLR-linked loans.
According to the RBI guidelines, the changes in the MCLR do not affect the fixed-interest home loans. Lenders must consider the deposit balance and other borrowings to calculate their marginal cost of funds. Moreover, institutions are required to publish the MCLR for various tenures. To know on Bajaj Finance MCLR rate, visit Finserv MARKETS.
Although the RBI has cut rates recently, the benefits of the cut may not be available immediately. You would need to wait for your reset period to complete. It is recommended to check the various terms and conditions to know when and how the MCLR cuts affect your home loan interest rate.
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