Factors That Influence Your Home Loan Interest Rate
The interest rate your bank charges on a home loan is your cost of credit. Interest rates determine the cost of borrowing money from banks and financial institutions. Lenders consider several factors while setting interest rates.
MakaanIQ lists the factors that go into arriving at the lowest lending rate offered by banks.
MCLR (or Base Rate)
Let us understand the concept of ‘base rate’ first. Base rate is the minimum rate set by the Reserve Bank of India (RBI). Banks are not allowed to grant a loan to applicants at a rate lower than the base rate. This is done to make credit markets more transparent, and to ensure that banks pass on the lowest cost of funds to their customers.
The RBI introduced a new methodology for calculating the benchmark lending rate for banks, from April 1, 2016 onward. This is known as the “Marginal Cost Fund Based Lending Rate” (MCLR). According to new directives, banks will have to set five benchmark lending rates for different time periods (overnight, one-month, three-month, six-month, and one-year). The base rate will be assessed according to the MCLR calculation, influenced by factors like the marginal cost of funds, tenure premium, negative carry on account of CRR (Cash Reserve Ratio) and the operating cost.
The repo rate is the rate at which the RBI lends money to banks in the event of any shortfall. It is a financial instrument used by the central bank to control inflation (i.e. when the repo rate is raised). If the RBI wants to put more money into circulation, it will lower the repo rate. When the RBI raises or lowers the repo rate, this will have an effect on the interest rate on banking products such as loans and mortgages.
Reverse Repo Rate
Reverse repo rate is the rate at which the RBI borrows money from banks. It is a financial instrument used by the central bank to control the money supply. An increase in reverse repo rate will lead to a decrease in money supply in the country, and vice-versa. This is so because this gives banks the leverage of parking their money with the RBI. So, this money will not be available for supply/credit in the market. An increase/decrease in the reverse report rate will have a direct impact on lending rates.
Cash Reserve Ratio (CRR)
Cash Reserve ratio (CRR) is a fraction of the total deposits of customers (i.e. who have deposits in the banks), which banks have to hold as reserves (either in terms of cash/deposits) with the RBI. This is done to ensure that banks do not run out of cash/money while meeting payment demands of their customers when they need money. The CRR is a very important monetary policy tool used to control the money supply in an economy. For instance, when bank’s deposits increase by Rs 100 and if the CRR is nine per cent, banks will have to hold Rs 9 with the RBI (as a reserve in cash/deposits), and use Rs 91 for lending/investment purposes.
Statutory Liquidity Ratio (SLR)
Every bank has to maintain a certain percentage of their “Net Demand and Time Liabilities (NDTL)” (net demand liabilities are payable on demand like saving deposits and time liabilities can only be used/withdrawn after a certain period of time) as liquid assets in the form of cash, gold etc. This ratio between liquid assets and NDTL is called the Statutory Liquidity Ratio (SLR). Maintaining the SLR restricts banks to pool more money into the economy. This, again, has an impact on lending rates.
Benchmark Prime Lending Rate (BPLR)
The Benchmark Prime Lending Rate (BPLR) has now lost relevance. But it is important to understand what it means because all retail loans were once linked to the BPLR. The BPLR is applicable to loans sanctioned before the base rate was introduced in July 2010.
The BPLR is the rate at which banks lend money to their credit-worthy customers. It was introduced to ensure transparency in the pricing of loans, according to the loan worthiness of applicants.
Let us understand this with an example.
Let us suppose that the BPLR is 10 per cent. An applicant who has many loans running and has never delayed or defaulted on paying loan installments approaches the bank for a loan. The bank decides to grant a loan to him at an interest rate that is lower than being charged on others. The bank will lend to him at an interest rate lower than 10 per cent (i.e. BPLR).
Many instances were reported in the past wherein banks lent at a rate as low as four per cent to big corporates/ names.
So, the RBI put a lower limit/ baseline to the BPLR, and this is called the base rate. No bank can lend money below the base rate.