As an existing home loan borrower, if you are expecting a reduction in interest rates in line with the recent Reserve Bank of India (RBI) repo rate cut, you could be disappointed. For those who had taken loans after July 1, 2010, but before April 1, 2016, the loans are linked to the lending bank’s base rate. And for most of these borrowers , the home loan interest rate is upwards of 10 per cent.
Under the base rate regime, the banks were either reluctant to cut their lending rates (post RBI repo rate cuts) or did so with a time lag. A new method of bank lending called marginal cost of funds based lending rate (MCLR) was put in place for all loans, including home loans, given after April 1, 2016.
So does that leave pre-April 1 base rate borrowers stranded? No, because now you have two options, either switch to MCLR with the same bank or else transfer (refinance from) to another bank on MCLR. One may also continue the loan on base rate, especially if the maturity period is near. Banks, on their own, typically reduce the tenure automatically and, thus, transfer the benefit of lower rate to the customers. Getamber Anand, President, CREDAI (Confederation of Real Estate Developers’ Associations of India) National, says, “Those who have loans on which MCLR is not applicable should consider opting for MCLR as the present trend indicates that the rates will either hold or go down again. This would play in their favour and allow room to manoeuvre in terms of personal and investment finance.”
The RBI has made it clear that banks should allow base rate borrowers to switch to MCLR. The existing loans can run till maturity or borrowers can switch to MCLR on mutually agreed terms, but the RBI has made it clear that the bank cannot either charge a fee for it or treat it as a foreclosure.
Switching from base rate to MCLR within the same bank
It makes sense to switch if the difference between what you are paying and what the bank is offering now as MCLR is significant. And also in cases where the time for the home loan to finish is not near.
An existing loan with an outstanding amount of Rs 20 lakh at 10.75 per cent, when switched to MCLR at, say, 9.5 per cent (the current trend in MCLR), could save about Rs 2.5 lakh of interest. Adhil Shetty, CEO and Co-founder, BankBazaar.com, says, “If you are in the base rate or even the BPLR (benchmark prime lending rate) regime, switching to the MCLR can bring down interest rates.” Therefore, ask your banker to calculate and inform you how much of interest can be saved by switching from base rate to MCLR and decide accordingly.
Switching loan from base rate to MCLR with another bank (refinancing)
If your bank is offering a high home loan interest rate (MCLR plus spread) then look for refinancing. Get the loan refinanced from a bank offering a low interest rate of around 9.5 per cent. “However, before you refinance your loan, compare and look around for offers and shortlist the most suitable ones. Make sure you consider all associated charges such as the transfer fees, legal charges, etc., and calculate the expenses before you take a call on transferring your loan”, says Shetty.
You may have to incur processing fees, which many banks waive off during the festive season. Anyway, the banks are not allowed to charge foreclosure or full repayment charges. Other charges may include lawyer’s fees, mortgage charges, etc. Remember, the bank may ask you to buy a home loan insurance cover plan, which is not mandatory. Get the loan insured through a pure term insurance instead, in addition to any insurance that you already have.
MCLR is more dynamic
The primary reason to switch from base rate to MCLR has to be the sluggishness seen in banks’ passing on the benefits of RBI rate cuts to borrowers. But where did the base rate model fail? Shetty says, “The MCLR uses marginal cost of funds, which include the interest rate at which the bank issues deposits, the cost of borrowings or the repo rate, as well as the returns on net worth. This means that each time the repo rate changes, the MCLR rate will change. Unlike this system, the base rate does not account for the repo rate. Hence, the changes to the repo rate may take an indefinite amount of time to reflect in the lending rates.”
Under the MCLR mode, the banks have to review and declare overnight, one month, three months, six months, one year, two years, three years rates each month. For most MCLR-linked home loan contracts, the banks reset the interest rate after 12 months for their home loan borrowers.
In a falling interest rate scenario, quarterly or half-yearly could be a better option, provided the bank agrees. But when the interest rate cycle turns, the borrower will be at a disadvantage.
After moving to the MCLR system, there is always the risk of any upward movement of interest rates before you reach the reset period. If the RBI raises repo rates, MCLR, too, will move up. Anand informs, “The main difference between MCLR and base rate system is the guaranteed change of interest rates. Where base rates allowed banks to avoid passing on the benefits of the rate cut to borrowers, with MCLR, the benefits are sure to trickle down to the consumers”
In addition to switching the loan from base rate-linked to MCLR and thereby saving interest, prepare a systematic partial prepayment plan to further reduce the interest burden.
Credits ET Realty