Borrowers should get rid of misconceptions about home loans and interest rates on home loans. Here is how interest rates are determined and why they fluctuate.
Through years of advising our clients on mortgages, one thing has become absolutely clear. Most prospective borrowers do not understand the real reasons behind a home loan interest rate fluctuation, and they will buy at least one mortgage in their lifetime without knowing how the mortgage will react post the borrowing. In fact, borrowers have the strangest insights and assumptions as to why the interest rate will change.
The Common Misconceptions!
Before we understand the real reasons, it would be beneficial to understand the common consumer misconceptions about home loan fluctuations.
Misconception I: RBI decides when a bank will increase/reduce rate of interest.
Misconception II:Home Loan provider HDFC Ltd is same as HDFC bank.
Misconception III:SBI is always the first one to reduce rate. They are always the cheapest one.
Misconception IV:Multinational banks have higher rate of interest. Further, MNC lenders do not give loans to borrowers who do not have big accounts with them.
Misconception V:All those who lend are 'banks'.
Misconception VI: Lenders only increase rates, but never reduce.
Demystifying The Real Factors
There are some important factors apart from monetary policies that govern the movement of interest rates. Potential borrowers need to keep a watch on these to get an idea on the possible movement of home loan interest rates.
There are several factors that stiffen or loosen the cash flow or cost of funds for the banks. When banks are under tight liquidity, they increase the base rate. Because of which, the rate offered to the borrower goes up and vice versa. Following are a few instances where banks have to pledge cash or security to the RBI; these, in turn, affect their cash flow and have an impact on the home loan interest rates they offer:
Repo Rate: The rate on which banks borrow against Govt. bonds as collateral from RBI, when they do not have excess fund.
Reverse Repo Rate: When banks have excess funds parked with RBI & get interest paid on it.
CRR (Cash Reserve Ratio): A specified minimum fraction of the total deposits of customers, which commercial banks have to keep as reserves with RBI.
SLR (Statutory Lending Ratio): The reserve requirement that banks are required to maintain in form of gold/government bonds before providing loans to their customers.
MSF (Marginal Standing Facility): The rate at which banks can borrow funds from the RBI overnight, against the approved government securities.
Overnight Rate: Rate that banks charge each other for meeting reserve requirements with RBI.
With the fluctuation of the any/multiple of the above, the banks tend to stiffen or loosen the lending rates in the market.
Impact on Future Borrowing
While we have analyzed the factors that cause home loan interest rates to fluctuate, let’s understand direct impact on the borrower when interest rates go down:
The interest liability goes down,
As a result the EMI (Equated Monthly Installment) becomes lesser
Loan Eligibility goes up
This opens up an entire window of options for the borrower. They could borrow a larger amount if they are fresh borrower, get a top-up with your current lender at a higher rate, or even switch your loan to another lender and get a top-up at the same rate. Knowing the real factors behind home loan rate fluctuations can not only give clarity but also give you the power to make great mortgage decisions. As this can get complicated, don’t hesitate to seek the assistance of professional advisory companies. Making the right decisions regarding your mortgage can result in a great financial advantage for you and your family. Understand & be a smart home loan shopper!