Should You Switch Your Home Loans To Repo Rate?

The Reserve Bank of India (RBI) in September 2019 directed banks and financial institution to link their floating-rate home loans with an external benchmark from October 1 that year, a move that was expected to bring greater transparency in policy transmission. The RBI provided banks with an option to link home loans either with the repo rate, the three-month or six-month treasury bill yield or any other benchmark published by the Financial Benchmarks India Private Ltd (FBIL).

While directing the banks to reset loan liabilities at least once in three months after they make the switch, the RBI gave them the liberty to decide the spread over the external benchmark.

Since then, all banks have linked their home loans with the repo rate, the rate at which they borrow funds from the RBI. These include State Bank of India, Bank of Maharashtra, Syndicate Bank, Bank of India, Bank of Baroda, Union Bank, Indian Bank, United Bank of India and Allahabad Bank, etc.

Experts are of the opinion that old customers, whose loans are linked with base rate, MCLR or BPLR, should also get their loan linked with the repo rate because of the sheer transparency and ease of doing business it would offer. Before you make up your mind about this, it would only be appropriate to make yourself familiar with the workings of the new rate regime and the manner in which it will impact your loan liability.

1. It is a floating-only option

Repo-linked lending rate (RLLR) loans are only available to those borrowers who are opting for a floating rate. Fixed rate home loans are priced differently and changes in the repo rate have no bearing on those, unless there has been a remarkable increase in rates, forcing banks to increase the interest.

2. Affordability may increase

A repo rate-linked interest regime, does not imply that loans will get cheaper. As has been the case with previous benchmarks, the repo rate will continue to be the guidance value, based on which banks will charge interest. Lenders will factor in the deposit rates and source of funds, to calculate the final interest. This could be 300-400 basis points above the repo rate. (One percentage point is equal to 100 basis points.)

However, RLLR loans would certainly be more affordable than the loans linked with the marginal cost of funds-based lending rate (MCLR), or base rate or prime lending rates.

3. Transmission of rate changes would be swift

Switching to the RLLR means rates might change every two months, since the RBI Monetary Policy Committee meets bi-monthly, to take a call on key lending rates. A reduction in repo rate should immediately reflect in the interest rate that the bank charges you. The same is also true, in case the RBI decides to increase rates.

4. You have to stay alert

Switching to the RLLR, means that the borrower will have to keep a close watch on the RBI monetary policy and keep himself abreast, with the changes that could decrease/increase his loan liability. He should also make changes accordingly, to maintain gains. In case he observes that his bank is not swift enough in making changes, he can consider moving the loan to a bank which is.

You may like to read: What is rest in home loan?

5. You would know the calculations

Since the repo rate is an external lending benchmark, the borrower would have a clear understanding of the calculation that his bank is using, in pricing the loan. So, you would know the repo rate, the spread the bank is using and also the intervals at which the bank would recalculate your liability. The same was not true, in case of internal lending benchmarks that banks have been using so far.

6. Bad credit means higher cost

Borrowers with a bad credit history, would have to pay a higher cost of borrowing. Experts say banks would charge 40-50 bps additionally, from borrowers who have poor credit history.

7. Greater risk appetite

Those who lack the appetite for risks, may continue with the MCLR regime, considering that changes in rates translate slowly in this case. So, even if rates increase, you may continue to pay the same EMI, because the bank has yet to recalculate your loan. However, this cuts both ways.

8. Keep saving

Those opting for RLLR loans, will also have to maintain a certain balance in their accounts in order to avoid default, in case rates are increased suddenly and the EMI amount goes up.