RBI rate hike: What you must know?

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The RBI has increased interest rates. What does this mean for you and your loans? Read on to find out more.

Why has the RBI increased interest rates?

The RBI has a role to play in adjusting interest rates in the economy to keep a check on inflation. Inflation is the general increase in the level of prices in the economy.

As you might have observed first hand, the price of everything from vegetables to petrol has been on the rise in recent months. So, in order to control inflation the RBI announced an increase in the repo and the reverse repo rates.

What is the repo rate?

Sometimes banks need to borrow money from the RBI. The RBI charges these borrowing banks a rate of interest. This interest rate is called the repo rate. If this rate is high, then banks will be forced to pass on these higher rates to its own retail customer.

When the reverse happens, when RBI takes money from the banks, the rate at which this loan takes place is called the reverse repo rate.

The repo rate has been increased from 5.50% to 5.75%, and the reverse repo rate from 4% to 4.50%.

Will my borrowing cost rise due to the rate hike?

In the medium terms, say 3-6 months, your borrowing costs are likely to go up for all kinds of loans such as home, auto and personal loans. This is because the rise in the repo rate will over time be passed on to the end customer.

However, some banks/lenders were running special schemes on teaser home rates whereby the rate of interest was fixed at say 8% or 8.25% for the first two years and then at say 8.5% or 9% for the third year. If you have already availed of these schemes, then your rate will not change.

If you are applying for a fresh loan, you will have to apply for the loan before these teaser loan deals expire if you want these low rates. In any case, after these deals expire, the bank is free to raise its rates based on market rates.

How will the base rate be affected by the repo rate hike?

The base rate regime for interest rates came into affect on July 1. Base rates are the internal benchmark rates that each bank must use to price its loan rates for loans offered to all clients.

Now that the interest rates have increased, it is likely that the next time that banks review their respective base rates they will increase their internal rate to reflect the rise in the repo Rates.

Banks are likely to review their internal base rates next in September and it is expected that these rates will rise from the current levels. As a result any new loans priced using the Base Rate will also experience higher rates.