Home loan rates will now be more sensitive to changes in policy rates. This is because with effect from April 1, following a directive from the Reserve Bank of India (RBI), banks have started linking home loan rates to the marginal cost-based lending rate or MCLR.
This is a welcome move for borrowers as the benchmark lending rate will now be linked to incremental deposit rates, which means banks will have to fix their lending rates on the basis of their current cost of funds. Earlier, the benchmark lending rate was the base rate, which depended on the average cost of funds.
Though the new formula will benefit borrowers, the interest rate and the tenure of their loans may change frequently now. The transmission by banks will now depend on the time-frame selected by them for calculating the revised rate. The new formula will apply only on new loans and not on the entire loan book of the bank.
Existing loans will still be linked to the base rate. Here is the lowdown on how the new MCLR regime will affect you.
According to the RBI, banks have to set at least five MCLR rates - overnight, one month, three month, six month and one year. Alhough they have to declare these rates every month, they have been given the freedom to choose the reset period. This is different from the single base rate formula that banks follow at present. So, under the MCLR, if you take a loan on May 1, 2016, and if the bank decides to cut rates on May 6, 2016, you will get the benefit only after a gap of one year. However, if your bank calculates the rate as per the MCLR for six months, you will be eligible for a lower rate much earlier. This will, however, not pinch you in a rising interest rate scenario. In the scenario discussed above, the bank will be able to pass on the rate cut after a year.
Considering the different reset dates, experts say home loan rates will become volatile. Sanjaya Gupta, Managing Director, PNB Housing Finance, says, "The situation is going to be very volatile for customers. Suppose rates are linked to the one-year incremental cost and home loans are for 30 years. How are banks going to adjust it? Given that it is a new way of calculating benchmark lending rates, the implications of the different reset periods will be known only in future."
Earlier, banks charged a mark-up on the base rate, called spread. Under the new norms, spread will be added to the bank's MCLR. Though most banks have set one-year MCLR 10-30 basis points lower than existing base rates, you should also consider the spread at the time of selecting a home loan. A higher spread could increase the lending rate. Base your decision on both MCLR and spread, don't look at the MCLR alone.
There is another issue. The MCLR is applicable only on floating rate loans, which experts say could lead to banks shifting to fixed rate loans. Adhil Shetty, CEO and Co-founder, Bankbazaar.com, says, "Banks still have the credit spread methodology for safeguarding themselves during a falling interest scenario. In such a scenario, we may see banks coming up with longer tenure fixed rate loans."
Rate cut by RBI
Usually, banks cut lending rates after the RBI does it. But last time was an exception as several banks had already cut lending rates before the RBI announced a 25 basis points cut in the repo rate on April 5. Experts say sooner or later rate cuts will be transferred but it will take some time for things to settle down.
Ashutosh Khajaria, Executive Director, The Federal Bank Ltd, says, "Impact of the MCLR may not be evident initially. Moreover, it has to be understood why banks are not able to pass on the full cut through their base rate. Only 1 per cent of a bank's borrowing is dependent on the repo rate. The other 99 per cent is contributed by other borrowings. Moreover, operating expenses remain the same."
What to do?
For existing borrowers, falling interest rates will yield a higher and quicker benefit if their loan is linked to the MCLR. But when the cycle reverses, a rising interest rate scenario will benefit borrowers with base rate-linked loans. New borrowers, in any case, do not have any option. Their loan will be linked to the MCLR. But before zeroing in on a loan, compare the tenure for reset of rates and the MCLR spread.
Naveen Kukreja, CEO, Paisa Bazaar, says, "The MCLR will bring in more transparency in loan pricing and interest rates in future. On the flip side, it may be difficult for banks to pass on the necessary benefits to borrowers if they don't cut term deposit rates."
In addition, the MCLR is applicable only on banks and not housing finance companies or HFCs. Considering that interest rate are slightly higher for HFCs, Rishi Mehra, Co-founder, Deal4Loans, a portal for comparison of retail loans, says, "On the basis of interest rates alone banks give better rates compared to HFCs. But on other parameters, such as eligibility, HFCs prove to be a better option." Banks are permitted to lend up to 75-90 per cent of the property value. HFCs offer loans after taking into consideration stamp duty and registration cost while calculating the total cost of the property. Mehra adds, "At the time of switching one should ask if one can switch back to the base rate regime as it varies from bank to bank."
The implications of the MCLR will be known only in future. You can wait for a few months to see the impact before you decide to switch.