Real Estate

What is MCLR And its Impact On Home Loan EMI?

Prior to 2016, home loan borrowers would not have encountered the term MCLR. This refers to the Marginal Cost of fund based Lending Rate. Currently, this is an option offered by banks, housing finance companies and non-banking institutions with reference to the interest rates that are charged by them. 

Previously, the interest rate charged was linked to the Repo rate (Repossession rate) or Base Rate that was determined from time to time by the central bank of the country, namely the Reserve Bank of India (RBI). 

What Is MCLR?

There are two ways by which lenders recover interest on the loans granted by them, whether home loans or home mortgage loans .  The Repo linked loan rate, as mentioned earlier, is subject to frequent revisions as mandated by the Reserve Bank. It can also differ across lenders. Repo rate is also linked to other factors such as Loan to Value ratio, risk factors, loan amount and more. This means that the interest rate on the home loan moves up or down based on the Repo rate. 

However, MCLR rate is set by the bank itself, based on guidelines set by the RBI. It refers to a minimum rate below which the bank cannot lend. The bank determines this rate based on its own operating costs, profit margin and more. This rate is applied across all types of loans, including home loans. The interest rate is on the home loan (or spread) then becomes determined at a fixed percentage higher than the MCLR rate. 

The higher the MCLR, the higher the interest rate, and vice versa. MCLR is designed to address certain issues faced by borrowers in the Repo rate regime. It allows you to take advantage of the rate cuts imposed by the RBI from time to time. 

The main components of MCLR include:

  • Operating Costs: These are the regular expenses incurred by the bank such as salaries, rent, utilities and other costs
  • Tenure premium: For longer term loans which are considered a higher risk by the bank, a premium is applied 
  • Negative Carry-On Cash Reserve Ratio: Banks are required to deposit a non-interest earning reserve with the Reserve Bank. The negative cost associated with this reserve is considered to be a carry-on reserve. 
  • Marginal Cost of Funds: The cost of obtaining additional funds is calculated by the bank.

The MCLR is periodically reviewed by banks usually on a monthly or quarterly basis. This depends on the individual lender’s assessment of its own cost structure. Each bank has the flexibility to determine its own MCLR based on RBI guidelines. There are five different periods of MCLR to be published. These include overnight, one, three and six months and one year. 

Benefits of MCLR

  • More transparency in calculation of interest rates
  • Lower interest rates can be passed on to customers
  • More fairness in both lending and borrowing processes

How Does MCLR Impact Home Loan EMI?

MCLR is considered to be the internally determined benchmark of the lender. All loans that have been availed after 1 April 2016 are linked to the MCLR system. If you have taken your loan before this date, you can switch to this system. 

The MCLR regime has a major impact on your EMI (equated monthly installment). When the Repo rates (or Base Rate) are lowered by the RBI, your EMI will get concurrently lowered, but if the rates are increased, your EMI will also go up. Earlier it was noticed that when the Repo rate was increased by the RBI, banks were quick to increase their lending rates, but when the Repo rate was lowered, there was no urgency to reduce the rates. MCLR aims to prevent this anomaly.

The MCLR system aims to make it easier and simpler for the borrower to take advantage of the lower rates of interest as and when they get implemented. 

In certain cases such as car loans, personal loans and fixed rate interest loans, MCLR does not apply. In case of loans associated with government schemes, non-banking financial institutions and housing finance companies, MCLR is not applicable. 

If you’re choosing a home loan within the MCLR regime, note that it is possible only if you opt for a floating rate of interest. 

You get the advantage of changing interest rates in tandem with RBI repo rates whenever these are lowered. 

However, if you have an existing home loan with the Repo rate regime, you may have to incur certain conversion costs levied by the bank if you want to switch to the MCLR regime. 

Banks must display the MCLR of the current month on their websites and in all their branches before the end of every month. Generally, banks use the six month or one year MCLR as their benchmark rate. Your home loan will be reset accordingly. This means your tenure or your EMI could change correspondingly. 

You need to do your own research, comparative analysis and shopping to get the best possible EMI that is in sync with your own unique budgetary requirements and preferences. When you choose the home loan online apply option on your bank’s website, you can simultaneously calculate your EMI based on the MCLR regime. 

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