How would you feel if you are paying higher interest rate on your home loan even as the policy rate has fallen by about 2 per cent in a span of 10 months? This is what is happening with home loan borrowers under the MCLR regime whose interest rate reset period is still two months away. MCLR-linked home loans come with a reset period of one year. However, the country's biggest lender SBI has reduced it from one year to six months giving many borrowers an early advantage of reduced interest rate. Those with other lenders are still stuck with one-year reset period and paying higher interest rate. Although it is wise to go with the reduced reset period, there could be some pitfalls. Borrowers need to weigh in all options. We tell you best options to get the advantage of reduced interest rates:
SBI is not alone with the shorter reset period
ICICI Bank, Kotak Mahindra Bank and Axis Bank are few other lenders with six-month reset period of MCLR-linked loans. Many banks already had the provision much before the announcement was made by the SBI. "Banks which have their MCLR-linked loans under annual resets can shift to shorter resets if their own interest rate outlook points to bottoming out of the repo rate and other broader market rates," says Ratan Chaudhary - Head of Home Loans at Paisabazaar.com.
Other banks may follow suit to prevent their borrowers shifting to other lenders with much lower interest rate. "SBI is one of the largest consumer banks in the country and with them having taken the lead, other banks are likely to follow the move. This would help borrowers across the spectrum," says Aarti Khanna, Founder and CEO, Askcred.
Faster reset can be a double-edged sword
While faster resets may appear attractive in the falling interest rate regime, if the interest rate cycle changes it will hurt you badly. "In a falling interest rate scenario, as it is today, the shorter reset period of six months will benefit customers. However, when interest rates begin to increase, EMIs will also go up faster," says Khanna of Askcred.
Strategically timed to benefit lenders
Repo rate at 4 per cent, which is one of the external benchmarks in the new interest rate regime, is at the lowest level seen in the last decade. As a result, the current interest rate is almost close to bottom. While further rate cuts cannot be ruled out in the near future, the chances of a significant rate reduction are slim, but there are all the possibilities of interest rates going up.
MCLR regime is known to be slow in transmitting the interest rate reduction as it passes the rate cuts with a delay. As four months have already passed since the last repo rate cut in April, the banks are supposed to transmit the reduction to the borrowers in the MCLR regime. As the chances of rates going lower are lesser, the borrowers are unlikely to benefit from quicker rate reduction. On the other hand, if the rates go up, the hike will be quickly passed on to the borrowers.
External benchmark is a better option
Despite the low probability of further rate cuts, an external benchmark-linked interest rate will be beneficial for the borrowers. If the low interest rate regime continues for long you will keep enjoying the lowest interest rate under EBR. And if the interest rate goes up, loans under all regime will get affected. If you are stuck with MCLR, which is currently at 7 per cent (one year) for the SBI, you may be asked to pay a higher interest rate than 7.5 per cent. If you are still stuck with much older base rate regime with the current base rate of 7.4 per cent, banks charging an interest rate of 8 per cent will not be surprising.
On the other hand, the lowest rate offered by the SBI on home loan under EBR is 7 per cent, which is offered to salaried borrower for a home loan up to Rs 30 lakh with LTV ratio below 80 per cent and the borrower should not fall under Risk Grade 4-6. However, female borrowers receive a discount of 0.05 per cent, which brings down the interest rate to 6.95 per cent.
Under EBR, the frequency of resetting the interest rate is lowest which is on a quarterly basis. While interest rate will keep changing on the basis of changes in the benchmark rate, the spread once decided at the time of sanctioning the loan can only be changed after three years and only if there is significant change in the borrower's credit profile. So, by looking at the changes in the external benchmark rate every quarter, you can figure out your effective rate by adding the spread to the EBR. "The rate setting mechanism in the external benchmark regime is much simpler and more transparent than MCLR-based regime. Borrowers of loans linked to external benchmarks get swifter transmission of changes in the repo rate or other underlying external benchmark rates, irrespective of the cost of funds of their banks," says Chaudhary of Paisabazaar.com.
MCLR borrowers better off by switching to EBR
If you are a new borrower going for a floating rate home loan or an old borrower transferring your home loan to a new lender, you will automatically get the interest rate linked to an external benchmark.
However, if you are a home loan borrower still stuck with the MCLR regime then each month you may be paying unnecessary high interest amount in your EMI. It is time for you to transfer your loan. "With housing loans, one can always transfer a higher interest loan from one lender to another offering lower interest without prepayment penalty; hence the MCLR regime adds only limited value," says Khanna of Askcred.
However, if you decide to switch you may incur some cost in terms of processing fee. Therefore, it makes sense for you to calculate the net benefit from the transfer. "Those comfortable with swifter changes in their lending rates - both upwards and downwards - can shift to the external benchmark regime. However, keep in mind that banks may charge a one-time switchover fee for migrating to the external benchmark regime," says Chaudhary of Paisabazaar.com.
If you are one-two years away from closing your loan, switching it to the new benchmark may not be a good idea as switching cost will significantly reduce the benefit that you will get from the lower interest rate. However, if the remaining tenure of your loan is longer, you may consider a switchover. Typically, if the interest rate advantage is 0.5 per cent or more, it will be beneficial to switch your loan factoring in the switching charges.