A reduction in the repo rate is a good news for home loan borrowers because of the fact that the rate cut has a direct impact on the home loan interest rate and home loan EMI (Equated Monthly Instalment). The existing and the potential home loan borrowers got this good news on June 6, 2019, when the Reserve Bank of India (RBI) slashed the repo rate by 25 basis points (bps), bringing it down to 5.75%. This is the third consecutive rate cut by the central bank this calendar year. The repo rate, which was 6.5% at the beginning of the year, was cut twice before this by the RBI by 25 bps each time, in February and April 2019.
What is Repo Rate?
Repo rate is the rate at which the RBI lends money to banks. To understand it better, if a bank takes a loan of Rs. 100 from the RBI, it pays Rs. 5.75 as an interest to the RBI, if the repo rate is 5.75%. It is one of the key instruments used by the RBI to deal with inflation and deficit of funds and liquidity in the market. The RBI increases the repo rate to reduce the borrowing by banks. This eventually reduces liquidity in the market and helps control inflation. When RBI wants people to borrow money or to push money in the economy, it decreases the repo rate. On the other hand, when banks have excess money, they deposit it with the RBI. The rate at which the RBI offers to deposit the banks’ money is called reverse repo rate. Thus, repo and reverse repo rates influence not only price stability but also bank lending and investment rates.
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What is the Impact of Repo Rate Cut on Home Loan EMIs?
Now, let us understand the relationship between repo rate cut and home loan EMIs. A decrease in repo rate also decreases the fund-borrowing cost for banks. And when banks get funds at a lower rate, they are in a condition to decrease the Marginal Cost of Funds Lending Rate (MCLR). This, in turn, allows customers to get MCLR-linked loans at a cheaper interest rate, resulting in lower EMIs. However, this is possible only if banks and housing finance companies pass on the benefit of the rate cut to the customers. The reality is that banks and housing finance companies are not so quick in lowering the home loan interest rate because of various reasons. A tight liquidity condition for banks is one of the reasons. And even if they do so, there are other factors like reset date that prevents customers from enjoying an instant decrease in EMIs.
Let’s take an example of a borrower who has taken an HDFC home loan of Rs. 30 lakh at an interest rate of 8.85% p.a. for a tenure of 20 years. Assuming that the bank passed on the benefit of repo rate reduction of 25 bps to its customers and lowered the interest rate to 8.60%, here are the details of the old and new EMIs.
| Particulars | Details (6% Repo Rate) | Details (5.75% Repo Rate) |
| Principal Amount | Rs. 30 lakh | Rs. 30 lakh |
| Loan Tenure | 20 years | 20 years |
| Interest Rate | 8.85% | 8.60% |
| Monthly EMI | Rs. 26,703 | Rs. 26,225 |
| Difference in EMI | Rs. 478 | |
| Total Interest Amount | Rs. 32,93,971 | Rs. 34,08,733 |
| Difference in Interest Payable | Rs. 1,14,762 | |
Thus, if the full benefit of 25 bps repo rate cut is passed on to the borrower, the EMI is reduced by Rs. 478. The difference between the two monthly payments would seem negligible, but the total reduction in the interest would amount to approximately Rs. 1,14,762. Assume that all the three reductions (75 bps) were translated into home loan rate cuts, multiply the savings (Rs. 1,14,762) by 3. Thus, the total savings would have been Rs. 3,44,286.
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What is the Effect of Repo Rate Cut on New and Existing Borrowers?
Home loan borrowers get 2 types of loan interest rate – fixed and floating. In a fixed rate scenario, the interest rate remains the same during the entire loan tenure. For floating, the rate changes during the loan tenure as it is calculated on the basis of MCLR, Benchmark Prime Lending Rate (BPLR) or base rate. On the basis of these interest rates, a repo rate cut affects new and existing borrowers differently.
1. Effect on New Home Loan Borrowers
The above example would seem quite attractive to a new borrower. However, he/she might not get to benefit from this change because the RBI has postponed its decision to link home loan interest rate to an external benchmark like repo rate. Therefore, for a new borrower, the interest rate would be linked to the bank’s MCLR. And after a repo rate cut, the bank does not immediately lower the MCLR rate.
2. Effect on Existing Home Loan Borrowers
-For MCLR-linked Interest Rate
For borrowers whose loan rate is linked to MCLR, the borrowing cost will change only when the bank changes the MCLR. And it is not necessary that the bank will reduce the MCLR as soon as the repo rate is cut. And even when it does, the borrower might not be able to enjoy the benefit instantly because the changes in the rate are made effective from the reset date. Banks usually offer floating home loan rate with a reset duration of 6 months or 1 year. Reset date is the time when the adjustable home loan rate is scheduled to be changed. Therefore, even if a bank changes the MCLR in July 2019, a borrower with a reset date in October will not avail of the benefit in July 2019.
-For BPLR-linked Interest Rate
As per RBI guidelines, all loans disbursed after April 1, 2016, must be linked to MCLR. So, if you have taken a loan before this date and your home loan is still linked to BPLR, it would be prudent to switch to MCLR-based loan rate. Your bank might help you do the needful or you may switch to another bank offering a better deal. Banks also give an option to shift to the MCLR-linked rate of interest at mutually acceptable terms. According to industry experts, calculation for MCLR is transparent and better.
