After two consecutive cuts in March and May, the current repo rate for 2020 stands at 4%. Notably, changes in repo rates have a direct impact on the interest rates of financial products, including housing loans. It tends to affect both new and existing borrowers significantly by influencing the loan EMI, among others. To understand this impact, individuals must become familiar with the cause and effect of the repo rate in detail.
What is the repo rate?
Fundamentally, it is a rate at which the RBI lends money to financial institutions. Repo rate is considered to be a pivotal instrument to combat the impact of inflation, cash deficit and liquidity in an economy. For instance, to lower liquidity and to control inflation, the RBI restrains the borrowing capacity of financial institutions by increasing the repo rate. Conversely, to infuse liquidity into the economy and to encourage borrowing, it cuts down the rate.
This strategic change also influences the borrowing and repayment pattern of borrowers. It must be noted that out of the 2 repayment components, namely, the principal amount and interest rate, the loan amount remains fixed throughout the tenor. However, being a variable component, the loan interest is susceptible to any change in repo rate, and, in turn, influences one’s loan burden.
Impact of repo rate on home loan EMIs
A change in the repo or repurchasing rate influences home loan EMIs to a great extent. In simple words, a decrease in this rate leads to a reduction in the interest rate accompanying home loans. Resultantly, the home loan EMI burden also comes down. On the other hand, an increase in repo rate increases the rate of interest accompanying the housing credit and in turn, increases the monthly instalment.
Individuals must note that a lender decides the interest rate applicable to retail loans based on an external benchmark rate, presently the Repo Rate Linked Lending Rate (RLLR), which is ultimately linked to the RBI’s lending rate.
Impact of change in repo rate on borrowers
Unlike fixed rates of interest, the floating rate tends to change throughout the loan tenure. It is computed based on –
- Lender’s spread
- Borrower’s eligibility, etc.
Notably, rate cuts impact new and existing borrowers differently.
Impact on new borrowers
The recent rate cuts are attractive for new borrowers; however, they may not benefit from it immediately. It is because the RBI has delayed the process to link the home loan interest rate to an external benchmark. Nonetheless, intending borrowers can lower their loan burden significantly through effective negotiations to decrease their home loan interest. Typically, a high credit score, steady source of income and a clean credit history helps borrowers to secure credit at an attractive rate of interest.
Impact on existing borrowers
The home loan rates for those whose interest rate is linked to MCLR (a soon-to-be phased out internal benchmark lending rate) will change when the financial institution decides to amend its benchmark rate policy. Usually, a change in repo rate takes longer to reflect in MCLR rate as these rates are modified on the reset date. Notably, loans availed before 1st April 2016 and linked to BPLR (Benchmark Prime Lending Rate) may switch to RLLR-linked credit for transparent computation of interest rates.
Existing borrowers can further lower their loan burden by requesting for better terms of service from their financial intuition. They may also consider choosing a home loan balance transfer and switch their debt to a leading financial institution that charges affordable rates and extends comfortable repayment terms.
Some leading financial institutions also provide customers with pre-approved offers which make the process of availing credit less cumbersome. Usually, such offers accompany several financial products, including home loans and loans against property. Check your pre-approved offer online by sharing your name and contact details.
It must be noted that home loan interest rates are closely linked with repo rates and are revised periodically. Also, unlike the MCLR-linked system, borrowers availing under the RLLR are more likely to receive all benefits of rate cuts.