Several leading banks recently increased their MCLR rate in anticipation of the Reserve Bank of India raising the repo rate. So, what does this mean for a home loan borrower? Does MCLR really impact borrowers? Let’s find out.
But before we do, let’s understand what MCLR is.
MCLR is the Marginal Cost of Funds based Lending Rate. About two years ago, the RBI issued new guidelines for setting the lending rate (on loans) by commercial banks under MCLR. It replaced the existing base rate system from April 2016 onwards for all loans at a floating rate.
Back then, the move was widely celebrated as the interest rates of MCLR-linked loans were relatively cheaper, which benefited new borrowers. However, since 2016, a lot has changed.
In this backdrop, we debunk a few misconceptions about the MCLR cut that will help you understand its impact on your loan repayment.
Debunking the myths
Myth I: New and existing borrowers are treated equally
Well, unfortunately, this is one of the biggest myths that exist. In the past, the RBI tried to bridge this gap by introducing the concept of base rate. Even the National Housing Bank came out with a directive for housing finance companies such as LIC to treat new and old customers equally by charging the same interest rate.
However, not much changed!
Banks, on the contrary, introduced schemes for existing borrowers where they will have to pay if they want to migrate to the new (read low) interest rates. In a nutshell, the new and existing borrowers repay the loan at a different interest rate.
This also leads to confusion where existing borrowers feel that the reduced MCLR rate cut will mean that their interest rate will decrease immediately.
The importance of the reset period
Let us now introduce you a term called ‘reset period’. The reset period under MCLR varies from bank to bank. For instance, in SBI, it is one year (the highest allowed by RBI), while in HSBC it is three months.
So, one has to wait till the reset period is over to enjoy the benefits of the MCLR cut. In simple words, you cannot transfer your loan to MCLR unless the reset period is over.
Myth II: MCLR cut is directly proportional to the interest rate cut
Next comes the confusion pertaining to the home loan interest rates. Home loan borrowers, often, think that MCLR cut is directly proportional to the interest rate cut for new borrowers.
This holds true only for existing borrowers and not for new borrowers.
For instance, let’s assume that the existing MCLR was 8.25% and the spread was 0.25%, resulting in an interest rate of 8.50%. After the cut, let’s assume the MCLR is reduced to 8%. Now, in an ideal scenario, the net rate should be 8.25%. But this wouldn’t be the case as banks will increase the spread over MCRL from 0.25% to 0.50%, making the net rate still the same 8.50%.
MCLR is only for the banks governed by the RBI. Housing finance companies do not come under the purview of this rate cut.
So, is it a wise decision to shift your loan form the base rate to the MCLR?
Well, not really!
This is another common misconception where borrowers think that changing their home loan from the base rate to MCLR is a great idea.
While it might be good in certain cases (a lot depends upon the bank), there is also a disadvantage.
Under the base rate, the home loan reset date is every three months whereas under MCLR the reset period is one year. Even if you shift, the interest rate will remain the same for one year or whatever the reset period is.
All said and done, do not take financial decisions in haste and do not get carried away by the MCLR cut and shift your home loan from base rate to MCLR without consulting a finance expert.
It is always advisable to do the relevant calculations before jumping to any conclusion.
Have you ever shifted your loan from base rate to MCLR? Did you reap any benefits? Do let us know in the comments below!
Further reading:
Syndicate Bank revises MCLR rates
Bank of Baroda raises MCLR by 0.05%
Andhra Bank increases MCLR for various tenors
