Shall You Switch Your Existing MCLR-based Loan to Repo Rate Regime or Continue with the Same?

Last Updated : Feb. 14, 2020, 12:42 p.m.

The Reserve Bank of India (RBI) has cut the repo rate by more than 100 basis points in the Calendar Year 2019 in a bid to propel the economy that is facing slowdown. The low inflationary scenario prevailing for most of the year helped the central bank continue with its rate cut marathon. However, for the last two monetary policy meetings, the RBI didn’t make any changes. As a result, the repo-linked lending rate of most banks remained still.

The increasing inflation for the last 3-4 months made the RBI hold on to the repo rate, the rate at which the apex bank lends to commercial banks for their short-term obligations. The news of retail inflation surging to a 68-month high of 7.59% in January 2020 will only hinder any changes, at least, in the near term. If at all the change will be made, the repo rate could go up, raising the lending rates of banks.

Now that makes it interesting to know whether the old home loan borrowers continue to service the debt under the Marginal Cost of Lending Rate (MCLR) regime or switch to Repo Linked Lending Rate adopted by banks a few months back. If you are servicing the home loan at MCLR, you can read this post to take the right course of action.

MCLR-based Home Loan Rates Have Fallen Despite No Action from RBI in the Last Two MPC Meets

Recently, the two big guns in the home loan segment, State Bank of India (SBI) and Bank of Baroda (BoB), have cut the MCLR despite RBI holding on to the policy rate. SBI, for the 9th consecutive time in the financial year 2019-20, has cut the MCLR with the latest one effective from February 10, 2020. SBI cut the MCLR by 0.05% across tenors. With that, its 1-year MCLR has fallen to 7.85% from 7.90% earlier. Taking that into consideration, the interest rate on home loans stands at 7.95%-8.65% per annum. On the other hand, Bank of Baroda has cut its 1-year MCLR by 0.10% to 8.15% from 8.25% earlier. With that, the lending rate comes as 8.15%-9.15% per annum.

Why did banks make such rate cuts when the RBI held on to the repo rate for the second time in a row? A question worth asking! After all, the repo rate movement determines the cost of funds for lenders and the eventual rates they offer to borrowers. Well, the RBI while announcing the monetary policy on February 6, 2020, disclosed long-term repo operation for upto ₹1 lakh crore. This makes the cost of funds cheaper for banks, and as a result, lenders like SBI and BoB have transmitted the benefits to borrowers with lower interest rates.

How Does the Long-term Repo Operation Make Cost of Funds Cheaper for Banks?

The RBI will conduct the term repos for 1-year and 3-year tenors from the fortnight starting on February 15 at the policy rate. If the market experts are to be believed, this new exercise will help reduce the short-term rates. It will also reduce the deposit and lending rates of banks.

The Question Still Remains – Shall You Stay with MCLR or Switch it to Repo Linked Home Loan?

Do a cost-benefit analysis before you make any decision. Compare the interest rates and their movement in the recent past with regards to the policy rate actions from the RBI. If your home loan is with a bank marred by liquidity crisis, the repo rate cuts would have a very minimal or no effect on your lending rate. This must have pegged your MCLR-based home loan much higher than the repo linked lending rate. In such a scenario, you could think of switching to the repo rate regime. A word of caution – once you shift to this regime, any change (hike or cut) made by the RBI in the repo rate will have the same effect on your lending rate either way. This makes decision making even tougher.

So, you need to go back some years and find out how the MCLR-based lending rate behaved when the RBI upped the repo rate. You’ll find it banks were quick to raise the lending rate in the same proportion. But they were not reducing the lending rate to the tune of the repo rate cut. For example, If the RBI had cut the repo rate by 0.35%, banks were easing the MCLR rates by around 0.15%-0.20%. Keeping all that in mind, it will be worth switching to repo-linked lending rate so that your home loan rate goes in line with the repo rate changes. The fact that the spread portion remains fixed throughout the loan tenure makes loan pricing all the more transparent, much unlike the MCLR where lenders can change the spread portion as and when they deem so.