How and why will the current reduction in lending rates, affect home loan rates?

[ecis2016.org] To what extent will a reduction in the marginal cost of funds-based lending rate (MCLR) by a bank, impact one’s home loan rates and EMI? We examine

The substantial cut of 0.90% by the State Bank of India in its marginal cost of funds-based lending rate (MCLR), has created a lot of interest amongst the general public and borrowers, in particular. The general perception is that all the borrowers and specifically the home loan borrowers, will immediately get the benefit of this rate cut. Is it so? Let us discuss this.

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What is 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.

Who will get the benefit of reduction in MCLR?

Whether the reduction in MCLR by the banks, will benefit the existing customers or not will depend on various factors. The first factor is the interest rate regime, under which you had borrowed the money.

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In case you had taken the loan under a fixed rate, the benefit of reduction in MCLR will not be available to you, as your interest rate is fixed for the agreed tenure. Even if you had availed of the loan under a floating rate, whether the benefit will accrue to you or not, will depend on other factors.

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If you had availed of the loan prior to April 1, 2016, you would have done so, either under PLR (prime lending rates) or base rate regime and the benefit will not accrue to you immediately, unless the bank reduces its PLR or base rate. The benefit that you get, will also depend on the extent of reduction in the PLR or base rate.

Under the PLR regime, the rate of interest was linked to the PLR of the bank and the lending rate was generally at par or at a discount to the PLR. The base rate is based on the aggregate cost of borrowing of the bank and not the marginal cost of funding, which forms the basis for the MCLR.

How a change in the MCLR affects home loan rates

Under the MCLR regime, your 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 you, if you 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.

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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 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.

What can the borrower do, if the reset date is away or he has borrowed under base rate or PLR?

Borrowers under the base rate/PLR regime, can switch from the base rate to the MCLR on payment of applicable charges or even shift from one lender to another, after doing a proper cost-benefit analysis for the whole tenure. The decision to shift/switch would depend on various factors. The most important factor, is the difference in the effective rate of interest, between the rate you are paying and the rate of borrowing under MCLR if you switch/shift.

The balance tenure of the existing loan, also plays its part in the decision to shift/switch the loan. As the existing loans are under the floating rate, the banks do not charge you any prepayment penalty. So, effectively, you have to take into account the processing fee of the new lender or the charges to transfer the loan, which can range between 0.15% and 0.50%. In case the money is borrowed under the MCLR regime, the bank is bound to pass on the full benefit to the borrower, subject to reset date restrictions.

(The author is a taxation and home finance expert, with 30 years’ experience)

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