India's largest bank, State Bank of India (SBI), is first off the block to announce repo linked interest rates for retail loans including home loans from October 1. There is a shift from the earlier regime of marginal cost of lending rate (MCLR) where every bank's MCLR differs from each other and it was difficult to understand spreads charged by banks. Now there is a single external benchmark where comparison of interest rate would be easier for a borrower. What does SBI's new repo linked home loan rates tell us:
Marginal benefit to borrowers
SBI was charging 8.30 per cent floating interest rate under the MCLR regime for salaried home loan borrowers which needed up to Rs 30 lakh. Under the repo linked rate, the SBI has pegged the interest rate at 8.20 per cent per annum. The effective change is of only 10 basis points between earlier MCLR and repo linked regime. There is a similar 10 basis points difference as you go higher under the salaried category.
One good thing under the external benchmark system is that a borrower can compare the spread a bank is charging. As banks for example, have repo rate as a common external benchmark, the interest rates of two can be compared by deducting repo rate, say 5.4 per cent currently, to see spreads they are charging over and above the repo rate. In case of SBI, the spread is kept at 265 basis points over the RBI's repo rate. There is additional premium of 15 basis points. As a result, effective interest rate comes out to be 8.20 per cent for under Rs 30 lakh home loan. It would be difficult to compare the spreads and rates if two banks have different external benchmarks. Take for example, the RBI has allowed other benchmarks like 3 or 6 months treasury bill rate and any other benchmark published by the Financial Benchmarks India.
Ready for volatile EMIs
Borrowers have to be ready for frequent changes in EMIs as RBI reviews interest rates every two months. Banks are allowed to revise rates once every three months. The RBI is now mandated by Parliament to keep interest rates below 4 per cent. This makes interest rate setting more complex as RBI would react fast to any changes in the inflation outlook. While borrowers would benefit in a falling repo rate environment, the damage would be higher if the interest rates go up. The banks would be quick to hike EMIs, which would bring some imbalance as a retail borrower won't be able to keep up in terms of surplus funds to pay higher EMI. The option in many cases would be to increase the tenure of the loan. But these issues would play out when the interest rate cycle will take a turn to move northwards.
The Best bet
Don't be fooled by the lower repo rate as the interest rate that you would be paying in the rest of the life of the loan. The bank would be resetting the spreads after a three year period. Based on the initial experience or big losses (including net interest margins) in the portfolio, the bank would be resetting interest rates after three years. That interest rate change has the potential to increase the interest rates.
While low cost current and savings account or CASA constitutes almost half of the bank's funding mix, term deposit rates are sticky which increases the cost of funds in a rising interest rate environment. Experts suggest it makes sense to borrow from public sector banks as they would be in a better position when the interest rates go up in the economy.
Compare NBFCs interest rate
There are good NBFCs like HDFC where one can get a good deal. If one wants to avoid the uncertainty of banks repo rate regime, NBFCs like HDFC, LIC, GIC offers a good option. In fact, some of the NBFCs also have a fixed cum floating interest rate, which is a good product for those who want to take a near term interest rate call.