Your home loan depends on MCLR

The announcement on a levy of sops by Prime Minister Narendra Modi is all set to kindle the home loan segment and leading the pack is SBI, which announced cut in its lending rate by 0.9 per cent, with others following suit. It is good news for home buyers that rates are going down. Do not be blinded by the announcements alone, as lending rates are now linked to a new benchmark – marginal cost of funds-based lending rate, popularly known as MCLR. The new rate and benchmark came into being from April 1, 2016 compared to the earlier base rate-linked home loans.

What is MCLR?

It is the new benchmark lending rate at which banks will now lend to new borrowers. Although MCLR will be the benchmark rate for new borrowers, for existing borrowers (those with loans taken before March 31, 2016) the base rate regime will continue.

What factors impact MCLR?

TheMCLR is linked to the actual deposit rates. Based upon this MCLR, interest rate for different types of customers should be fixed in accordance with their riskiness. The base rate will be now determined on the basis of the MCLR calculation. The MCLR should be revised monthly by considering some new factors including the repo rate and other borrowing rates. Specifically the repo rate and other borrowing rates that were not explicitly considered under the base rate system.

As per the new guidelines, banks have to set five benchmark rates for different tenure or time periods ranging from overnight (one day) rates to one year (overnight, one-month, three-month, six-month and one-year). Banks are also free to set rates for longer durations, such as two and three years). 

What makes up the MCLR?

There are four parameters –marginal cost of funds, negative carry on account of CRR, operating costs and tenor premium. The negative carry on account of CRR is the cost that the banks have to incur while keeping reserves with the RBI. The RBI is not giving an interest for CRR held by the banks. The cost of such funds kept idle can be charged from loans given to the people. The operating cost is the operating expenses incurred by the banks and tenor premium denotes that higher interest can be charged from long term loans.

Which loans are linked to MCLR?

All floating rate loans will be linked to MCLR. At present personal loans and car loans have a fixed rate and will not be linked to MCLR. So, home loan and loan against property will be linked to MCLR. However, the State Bank of India has linked its personal, education and auto loans to its MCLR rate.

What is the benefit?

Loans linked toMCLR will have a reset clause in the loan documents, and there will be a spread. The reset clause will depend on which bank you borrow from – some have an annual reset clause, while some have a half yearly reset clause. The reset will not be arbitrary and depend on the deposit rates at that time. If deposit rates are higher, your rate will rise. If they are lower, your home loan rate will fall. The spread, is the margin that you pay over the MCLR, which means if the one year MCLR is 9.2 per cent and the home loan spread is 25bps, you will have the loan at 9.45 per cent.

Can you shift to MCLR?

Yes, you can shift from base rate to MCLR, but it comes at a cost. You will need to either pay a conversion fee or continue at the existing rate. For instance, if you are repaying a home loan at 9.7 per cent rate and the prevailing MCLR is 9.45 per cent, depending on the lender, the cost will vary. For instance, you will be offered the MCLR rate, if you pay a conversion cost, which could be linked to the principal of the loan.

Do the math before planning a shift. Most banks charge 0.50 per cent of the outstanding principal as switching charges. Some may ask for a flat fee. There will be other administrative costs as well. So, if the difference of is of 25 bps and more in the interest rate, and your home loan is of a long tenor – you should shift the loan. Anything lower, and you are not going to benefit much.

What should you do?

If you are an existing borrower, migrating to the MCLR system will make sense if the difference is 50bps or more. You also benefit from the immediate impact of any monetary policy changes than the earlier base rate system. If you are scouting for a home loan, compare what lenders are offering and go for the best rate linked to MCLR after taking into account additional costs like processing fee and administrative costs.