The new repo rate-linked home loans being offered by banks such as the State Bank of India could be cheaper for homebuyers and more transparent, but loan advisers warn that they also carry the downside risks of the monthly instalments increasing in size in the event of a sustained increase in the repo rate.
India’s largest lender, the State Bank of India, launched repo-rate linked home loans that came into the market on July 1. This was swiftly followed by several other public sector banks, such as Syndicate Bank, Bank of India, Union Bank and Allahabad Bank, who each announced home loan products that would be directly linked to the central bank’s repo rate.
MCLR-based loans
The interest rate for normal home loans given by banks are calculated based on the marginal cost of funds-based lending rate (MCLR), which is an internal reference rate set by banks.
This rate is nominally based on the RBI’s repo rate — which itself is the rate of interest the central bank charges banks — but in practice the calculation of the MCLR by each bank is opaque and complex.
“The MCLR could be different for different banks, and be influenced by various factors such as the risk assigned to the loan taker and other factors,” Roopali Prabhu, head of Investment Products, Sanctum Wealth Management, explained. “Because of that, the transmission [to the borrower] was not happening.”
“There was a constant complaint from customers that even under the MCLR regime and before that the base rate regime, the benefits of the cuts of the policy rate were not getting transmitted to the end consumer,” Gaurav Gupta, CEO of Myloancare said. “But, whenever there was an increase in interest rates by the regulator, the banks were very quick to pass that on.”
The RBI has, over four actions, cut the repo rate by 110 basis points, whereas, according to some estimates, banks have transmitted only a 29 basis point cut to the consumers. A repo rate-linked home loan is one way to speed up this process of transmission so that the end user can benefit from the RBI action.
The interest on the repo rate linked loans is not the repo rate itself, but is simply based on it. For example, the SBI repo-linked lending rate (RLLR) will have a base spread of 2.25 percentage points over the repo rate. The repo rate at the time of launching the product was 5.75%, which meant the effective RLLR would have been 8%.
On top of this, the bank will add a risk-based spread of 40-55 basis points, depending on the risk assigned to the borrower. Taking this into account, the effective interest rate on the loans would have been 8.4-8.55% at a time when home loans based on the MCLR were anywhere between 8.55% to 9.10%. The RBI has most recently cut the repo rate by 35 basis points, meaning the RLLR will be further lowered.
‘Pro-investor move’
“With the repo-linked rate, there is a lot more transparency being brought in,” Ms. Prabhu added. “As a home-loan borrower, you know what the rate is, what the spread is, and if you know what the reset date is, you also know what the rate will be following an RBI action and when it will come into effect. It is a very good move and from a transparency point of view, it is a pro-investor move.”
However, some consumers have the misapprehension that a repo rate-linked product will mean that the effective interest rate of the loan would change as constantly as the repo rate itself does, thereby making it more difficult for the loan taker to systematically make the payments. This, however, is a risk most borrowers already take when they opt for floating rate loans rather than fixed rate ones. “The decision first is whether you want a fixed rate or a floating rate,” Ms. Prabhu said. “Most go for a floating rate anyway. A lot of institutions encourage this. If you are going for a floating rate, you anyway have the vagaries of the rate going down or hardening. But this way [with repo rate-linked loans], at least you have transparency.”
That said, there are some risks the borrower undertakes when opting for the repo rate-linked home loans, such as the eventuality of the central bank raising the repo rate. This could not only increase the interest rate of the loan, but could also eventually impact the size of the instalments themselves.
“The customer must also understand that in the case of the repo rate linked loans, the changes in the interest rate can be more frequent and it could result in changes in the instalment amount itself, which was not the case in the MCLR regime,” Mr. Gupta explained.
“What used to happen is that in case there was an increase in the interest rate, the banks used to increase the tenure of the loan, and only in very rare cases where this was extended too much, would they adjust the instalment amount itself,” he added. “In the case of the repo rate loan, it’s not the same. There is a higher chance, if the repo rate is increased significantly over a short time, that the instalment amount itself could be increased.”
Sample calculation
An example will be illustrative to show how the loan can be affected if the repo rate is changed after a certain period of time. Say a borrower takes a loan of ₹50 lakh for a period of 10 years at the current repo rate of 5.4%. Her effective interest rate will be 8.05% (5.4 + 2.25 + 0.4) and the monthly instalment will be ₹60,796. Three months down the line, the RBI raises the repo rate by 25 basis points, which means the effective interest rate is now 8.3%.
If the loan tenure is kept unchanged, this will mean that the instalment will increase in size to ₹61,445. Similarly, if the RBI cuts the repo rate by 25 basis points from 5.4% to 5.15%, then the instalment will shrink to ₹60,151.
In a scenario where the monthly instalment increases due to RBI’s actions, borrowers will have to make sure that the higher amount is available in their bank accounts since the increase will take place automatically on the reset date.
