Who will benefit from the rate cut?

S. C Dhall

The current as well as the prospective cuts in home loan interest rates will undoubtedly benefit new home-loan borrowers. But what about the existing borrowers? Will they also benefit from the falling home loan rates?

For the existing borrowers, the rate cut would take time to reflect. This means that they may have to wait until the next reset period if they are on marginal cost of funding lending rate (MCLR). The reason for this is: if you have taken an MCLR-linked loan, the interest rate that you pay is subject to changes at fixed intervals as per the tenure for which the rates are linked. For instance, SBI resets the rates annually (from the date on which the loan is taken), while some other banks do so every quarter. Also, the change in the interest rates would usually be seen in the reduced tenure and not in the EMI unless you decide to re-finance your loan.

The MCLR system was adopted by banks from April 1, 2016, replacing the base rate system. Therefore, those who had taken home loans before April last year will have their EMIs linked to the base rate. Therefore, these borrowers will have to either enter into a fresh contract with their bank to get their loans linked to MCLR, or they will have to wait till their lender reduces the lending rate for them too. If that doesn’t happen, which is usually the case, then they should try to get their loan shifted to another lender by paying the required fee.

Increase in eligibility

New borrowers, however,  will see an increase in their eligibility with a 50 basis point drop in interest rates for a home loan. A borrower earning Rs 1 lakh per month  was eligible for a home loan of Rs 55 lakh for 20 years if the lender capped an EMI of 50 per cent on the monthly income. The same individual can now get Rs 58 lakh as home loan. For a 25-year-loan the eligibility goes up to Rs 62 lakh from the earlier Rs 59 lakh.

Reduction in tenure

For the existing customers the revision in  interest rates  can reduce the number of years remaining to repay the loan significantly. This is because banks usually do not change the equated monthly instalment of customers. Instead, they change the tenure whenever there’s a revision in interest rates. Thus, if your tenure was 25 years for a Rs 75 lakh loan at 9.15 per cent, after the 50 bps revision it would be brought down to 22 years. Similarly, if you had the same loan for 20 years, the repayment tenure would now be 18 years.

However,  home loans   linked to the marginal cost of funding lending rate (MCLR) may not see an immediate revision.

Widening disparity

The disparity in lending rates also exists for borrowers who have taken loans after April 2016, (after the MCLR was introduced). This is because, reduction in MCLR month-on-month, alone will not mean a reduction in lending rate. 

Unlike under the base rate system, where a revision in base rate was immediately reflected in lending rates of all loans benchmarked against it, under MCLR-based pricing, lending rates are reset only at specific intervals, corresponding to the tenure of the MCLR.

In case of SBI’s home loans, for instance, since the loans are benchmarked against the one-year MCLR, lending rates will only be reset every year. In April 2016, one-year MCLR stood at 9.2 per cent. The effective loan rate then worked out to 9.45 per cent. These borrowers, too, will end up paying 80 basis points more as interest on their loans than new borrowers.

What is marginal cost of funds-based lending rate (MCLR)

As the banks were not quick in passing on the benefits of the rate cuts announced by the RBI in the past, the central bank introduced a new basis for banks to determine lending rates, based on the marginal cost of borrowing, with effect from April 1, 2016. All the loans granted by the banks, are necessarily to be given under the MCLR regime. The MCLR takes into account the marginal cost of funds for the banks, for a specific period, to arrive at the final lending rate. 

What the SBI and other banks have done, is reduce their MCLR.

How a change in the MCLR affects home loan rates

Under the MCLR regime, home loan interest rate   will not change with each and every change in the MCLR. The banks are allowed to have a reset clause in the lending agreement, to fix the periodicity or date for change in the actual lending rate to the borrower. 

The premium, which the banks have over their base rate or MCLR for a particular loan, is generally called ‘spread’ and is expressed as certain points over the base rate or the MCLR.

The benefit of reduction in rates will accrue to  borrower, if the borrowr had already switched to the MCLR from the base rate or PLR regime.

For borrowers who had either borrowed under the base rate regime or had shifted to the base rate regime from PLR, the benefit will not be as substantial as the reduction in the MCLR.

Moreover, it will be available only as and when the bank announces a reduction in its base rate.

The existing borrowers, who have borrowed under the MCLR, will get a benefit if there is no reset period restriction or the reset period is over. As the banks have reduced the MCLR but at the same time increased the spread, new borrowers will not get the  home loan   at the same rate as the reduced MCLR. The new rates will be higher than what it would have been, had the banks not changed their spread.

However, the reduction in MCLR will certainly benefit the existing borrowers under this regime, as the spread will remain the same for them, unless they have a reset clause and the reset period is not yet over.