Will I get the benefits of a rate cut? Would my EMIs (equated monthly instalments) reduce? These questions get played almost on a loop each time the Reserve Bank of India (RBI) slashes interest rates. The RBI on its part has cut rates by 110 basis points so far this year.
But, as always, banks have been reluctant to pass on lower rates to borrowers, and even when they did, the gains to borrowers have been meagre. Recently, State Bank of India (SBI), Bank of Baroda, Central Bank of India, Allahabad Bank, UCO Bank, Syndicate Bank, etc. slashed their marginal cost of funds based lending rate (MCLR) rates by 5 to 25 basis points for different tenors after the RBI slashed rates by 35 basis points (bps) in August. One basis point is equal to one hundredth part of one per cent.
However, it’s important to know you may not gain from it any time soon, at least not in any significant manner. So, have MCLR loans failed borrowers? Here are some commonly misunderstood aspects about rate cuts and when they are passed on to borrowers.
Interest rates will be reduced immediately after MCLR cut
Despite the MCLR cut announced by banks, existing home loan borrowers will not get the benefit of it immediately. This is because of the reset period clause of banks. The reset period under MCLR varies from bank to bank. For instance, for SBI, the home loan reset period is one year, while for Kotak Mahindra Bank it is six months. As per RBI regulations, the maximum reset period allowed is one year. So, you have to wait out the reset period to enjoy the benefits of the MCLR cut. The reset period is usually mentioned in the loan agreement you have with your bank.
To illustrate, if you had availed a home loan from SBI on July 1, 2019, the interest rate will remain unchanged till June 30, 2020 despite the MCLR cut announced by the bank in August 2019. The benefit of the MCLR reduction will be passed on to you (existing home loan borrower) only on July 1, 2020.
The shorter the reset period, the better it is in a reducing rate scenario. You should consider a bank that resets interest rates every three months to gain from cuts quickly. However, only a few banks offer this option.
Housing finance companies too would reduce rates
At present, MCLR is the benchmark rate applicable only for banks. Housing finance companies (HFCs) link their home loan rates to the benchmark prime lending rate (BPLR) or retail prime lending rate (RPLR). As financial advisor Nitin Bhatia explains, “This is common a dilemma especially for home loan borrowers from HDFC Ltd, which is an HFC. When HDFC Bank announces an MCLR cut, borrowers from HDFC Ltd expect the rate cut benefit to be passed on to them as well.” But, in reality, both are different financial institutions and HDFC Ltd links its home loan rate with the RPLR, which is different from the MCLR.
Finance Minister Nirmala Sitharaman, in her maiden budget speech in July, had announced that the National Housing Bank (NHB) will not be the regulator of HFCs. Following this announcement, the RBI on August 13 said HFCs will be treated as one of the categories of NBFCs for regulatory purposes and that they will come under its direct oversight. It is expected that the RBI will review the regulatory framework applicable to HFCs and come out with revised regulations in due course. A retail banker, requesting anonymity, said, “Going forward, the benchmark for loans from HFCs may change from retail prime lending rate to the MCLR and external benchmark rates (such as linking with repo-rates) with RBI as regulator and this should reduce the dilemma of home loan borrowers as well as increase transparency for borrowers from HFCs.”
Interest rates are the same for all borrowers
There is a perception among new and existing home loan borrowers that both groups will pay the same interest rates to the bank during the tenure of their loans. However, that does not happen because there are multiple factors taken into consideration by the banks while determining the MCLR and interest rate of a borrower. Nitin Bhatia says, “Interest rates on deposits keep varying with economy factors, and therefore the cost of funds for the bank changes.” So, this leads to a difference in interest rates for new and existing borrowers.
For example, had you taken a home loan in April 2017, the interest rate charged would have been 9.5 per cent. A new borrower now, on the other hand, would pay only 8.5 per cent, as the cost of funds has reduced. Existing home loan borrowers will have to wait till the reset date to get the benefit of the MCLR cut.
Switching of loans between banks and HFCs is always beneficial
As a borrower, you may plan to transfer your balance home loan amount from an existing HFC or a bank.
However, before deciding to switch banks, you need to calculate the real savings and operational issues. There will be additional costs, which include processing fees and franking charges for a new lender. Also, operationally, you may have to make multiple trips to the bank for completing the process and re-submit loan documents to the new lender (bank). There have been instances where borrowers have ended up paying more during the tenure of the loan after transferring their balance to a different financial institution. “The difference between the existing rate of interest and the prospective rate of interest should exceed 75 basis points; only then does it makes sense to go for a balance transfer,” says Suresh Sadagopan, Founder of Ladder7 Financial Advisories.
Sukanya Kumar, Founder & Director of home loan advisory firm, RetailLending.com says, “You should not rush to transfer your loan. Often, these are marketing tactics of other financial institutions to achieve their loan targets.”If you are at the end of the loan’s tenure, switching to a bank offering a lower rate of interest may not result in much savings. Balance transfer is not always an economically wise decision; you need to negotiate with the existing lender before making a decision to switch.