Complex equation of rate-cut arithmetic

Most of the prospective home-loan borrowers wait for the Reserve Bank of India’s (RBI) monetary policy review before making a final decision to take a loan. This is because of the perception that the RBI policy stance impacts the home-loan interest rates.

Actually, how much your loan will ultimately cost you depends on a number of factors like what sort of loan you have taken. In case you have borrowed capital on a fixed rate of interest, the rate cuts by the RBI are not going to affect you. The interest rate variations are applicable only on loans taken on a floating rate of interest. But a repo rate cut may not always bring down your home loan interest rate. There have been instances where banks did not reduce rates despite the RBI making several cuts.

Is it beneficial for loan borrowers?

In the event of your lender implementing the changes, it is logical to assume that the rate cut will benefit you. But, the answer here is a ‘no’. Your bank can always tweak the spread to make things work in its favour. However, it is time that borrowers, both existing and new, stop waiting for the monetary policy review to decide whether or not to take a loan. As things stand today, the interest rate appears to either remain stagnant or there exists a remote possibility of it moving up in the near term. Unless liquidity in the system improves and inflation is well under RBI’s target, home loan borrowers, both existing and new, should be prepared to pay a high interest rate.

Is it worth the wait?

Remember, that as a borrower you have to keep your eyes and ears open to “fruitfully” track the ups and downs of the interest juggernaut. The onus of stimulating housing demand does not lie on interest rates alone. In fact, a host of other reforms and policy decisions taken by various stakeholders play an important part in generating demand. Measures such as the implementation of RERA, palatable payment plans for home buyers and relatively cheaper house prices , are some of the critical determinants for reviving the real estate sector.

Therefore, new home loan borrowers who have zeroed in on a property should go ahead and take the loan instead of waiting for a cue from the RBI. The existing home loan borrowers, with loans linked to MCLR, may, however, not witness any change in EMIs until the lending bank’s MCLR changes, which depends on repo rate, among other factors. Banks publish MCLR rates each month.

Better option?

Home loans are typically linked to six or 12-month MCLR of banks. These can either be fixed or a floating home loan. In a falling interest rate scenario, it helps to choose the latter, but potential borrowers may benefit from the former if the rate cycle turns.

Most banks, however, offer home loans linked to their one-year MCLR which is reset yearly. So, if one has taken a home loan in May 2018 and the RBI cuts repo rate in October 2018, even though the bank’s MCLR comes down in the same month, the effect of it for the borrower will be seen in May 2019 only. In effect, there is a waiting period (usually of a year) for the borrowers before they see an impact on their equated monthly installments (EMIs).

On the flip side, with banks increasing their MCLR, the possibility of home loan rates for the existing borrowers going up when the reset date arrives cannot be ruled out either. For new home loan borrowers, it’s only the MCLR-linked loans that matter. So, don’t wait any longer in the hope of an interest rate cut if you are thinking of taking a loan.

Take note

If you have already taken a home loan you can avoid a lot of hassles and bitter exchanges with lenders if you know some basic facts about home loans:

• Why do banks charge existing customers more than their rate for new customers? Is it a way to 'fleece' customers who they think are stuck with them?

Loans by banks are linked to their base rates (below which they cannot lend). The loan rate is usually base rate plus a margin, for example, base rate plus 50 basis points or bps. Banks arrive at the base rate after looking at their cost of funds and other factors. That is why it is different for each bank.

• As banks review their base rates at least once a quarter, floating rates may go up (or down) based on the call taken by each bank. Another option is switching of loan to low rate being offered to new customers by paying a small fee. Most banks offer this facility to retain customers. Banks do not publicize this facility and offer it to customers only on demand or when they ‘threaten’ to shift to another bank. That is why many customers are not aware of this. Not all lenders allow switching to a lower rate. Some, instead, reduce the tenure of the loan.
• Every time the RBI cuts interest rates, you are made to believe that your EMI will come down. But this is not always the case.

At 8 per cent, you pay Rs30.22 lakh interest on a loan of Rs30 lakh if the loan tenure is 20 years. The longer the tenure, the higher will be the interest payments and higher will be the chance that you will pay more interest than the principal amount.