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Last Updated : Sep 05, 2019 01:21 PM IST | Source:

Explained: Will the new repo-linked loan rate increase or lower your interest cost?

The RBI has made it compulsory for banks to link their new floating rate home, auto and MSME loans to an external benchmark from October 1 so that the borrowers can enjoy lower rate of interest.

Moneycontrol News @moneycontrolcom
Representative image
Representative image

What is external benchmarking of loans?
When you borrow money from a bank, be it for purchasing a house, car or for business purposes, interest is levied based on certain methodologies approved by the Reserve Bank of India (RBI). At present, banks use Marginal Cost-based Lending Rate (MCLR) to arrive at their lending rate. Prior to this, it was the Base Rate method and the Benchmark Prime Lending Rate (BPLR). These were all internal benchmarks. Banks have been allowed to use RBI’s policy rate among other market-driven options to calculate lending rates.

Why the need for a new method?
For faster transmission. Since February, RBI cut its policy rate by 110 basis points (100 bps=1 percentage point), including the higher-than-expected reduction of 35 bps in its August policy review. However, banks have not been so generous. Until August, they had only passed on 29 bps in rate cuts to borrowers, which the RBI thought was unfair. Hence, the regulator has now made it compulsory for banks to link their new floating rate home, auto and MSME loans to an external benchmark from October 1 so that the borrowers can enjoy a lower interest rate.

But I already have a home loan. Can I shift?
Yes, you can switchover from your existing method -- MCLR/base rate/BPLR -- to the external benchmark without any charges, provided you are eligible to prepay your floating loan without pre-payment charges as per the original terms. Else, you can switch on mutually agreed terms with your bank. While banks are free to charge a spread over the benchmark, RBI said the final rate after the switchover should be the same as the one that the bank is charging to new borrowers in the same category.

So, what’s the catch?Lending rates are on their way down in the current interest rate cycle. So, it makes sense to shift to a method that allows faster response to policy rate cuts in future. But it also means that the transmission will be as quick when interest rates start rising. Bankers are of the view that this may not bode well for individual long term borrowers due to volatility. A home or car loan borrower may be in for a nasty shock when rates start trending upwards. As per norms, these rates will be reset once every three months. This is, however, more transparent as compared to previous benchmarks.

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First Published on Sep 5, 2019 12:23 pm
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