What Exactly Is MCLR & How Does It Affect Your Home Loan EMI?
The Marginal Cost of Funds Based Lending Rate (MCLR), also known as the internal benchmark of a financial institution and the lowest rate at which a loan can be obtained, has been in the news since its inception in 2016 with reference to repo rate revisions by the Reserve Bank of India (RBI). With the introduction of repo rate-based loans, here is everything you need to know about the MCLR system.
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The phenomenon of global inflation has caused price increases. The Reserve Bank of India (RBI) started adjusting the repo rate in May 2022 in an effort to manage them. The rate was raised to 6.5 percent after being raised by a total of 250 basis points (bps) six times since that period. The RBI has held the repo rate steady even though another such increase was anticipated during the recently concluded Monetary Policy Committee (MPC) meeting. But how does the repo rate relate to the lending rate based on the marginal cost of funds? (MCLR). Let’s condense the term and examine how it affects your EMI expenses.
MCLR: What is it?
In the past, banks’ interest rates were based on the “Base Rate” system. It was the interest rate below which banks could not afford to provide loans.
In order to fix interest rates, the MCLR, or Marginal Cost of Funds based Lending Rate, approach was implemented in April 2016. It was hinted that starting on April 1, 2016, the MCLR would be used as the benchmark for all rupee loans provided and credit limits renewed. It is now the benchmark interest rate that banks use internally when granting loans.
MCLR-affecting variables
The primary factors in the MCLR calculation are:
Marginal Cost of Funds: The most distinctive aspect of the MCLR regime is the marginal cost of funds. It is determined, among other things, by the interest rates offered on savings accounts, term deposits, short-term interest rates, or repo, and return on net worth.
Operating expenses: These are the expenses banks incur to run their businesses.
No return on Cash Reserve Ratio (CRR): Banks receive no interest on the reserves they maintain with the RBI under the Cash Reserve Ratio (CRR).
Tenure premium: It denotes that longer-term loans may be subject to higher interest rates.
Important distinctions between the Base Rate and MCLR systems
The method used to determine marginal cost differs significantly between the Base Rate scheme and the MCLR. Using a simple average of the interest rates paid on deposits, the base rate system determined it.
However, under the new method, interest rates are determined by the criteria listed below:
- The marginal cost that the bank incurs to arrange the deposits is calculated
- In contrast to the Base Rate approach, the repo rate is now factored into the marginal cost. It implies that the adjustments in repo rates put into effect by the RBI are directly tied to the new interest rates.
- Banks take minor interest rates into account when estimating costs.
- According to the computation method, the MCLR rates should be updated each month.
What kinds of loans are MCLR-linked?
The MCLR rate governs all loans approved with a fluctuating interest rate after April 1, 2016. Existing customers can decide to use the new system instead. Under MCLR, the following loans are protected:
- Home loan
- Loan against property
- Corporate term loan
Amounts exempt from the MCLR
All loans are subject to MCLR, with some exceptions, such as:
- Fixed-rate personal, auto, and mortgage loans
- loans related to a government programme
- Housing finance organisations and nonbanking financial entities
Should your loan be switched to the MCLR rates?
The determination of marginal cost is the key distinction between the Base Rate System and the MCLR. In the base rate system, it was determined by taking the interest rates’ simple average. Additionally, because the MCLR rates are tied to repo rates, your Equated Monthly Instalment (EMI) is anticipated to change in response to changes in the repo rate.
The transition to the MCLR system is easy. Before switching, one must, however, always make sure and do extensive research. It could cost the customer money and isn’t always beneficial.
Why don’t banks provide clients the benefits right away?
There has been a general consensus that banks do not immediately pass on savings from decreased repo rates to clients. The banks’ “Reset Period” clause is the cause of this. It fluctuates between six months and a year depending on the bank. For instance, the State Bank of India (SBI), a public institution, has a one-year reset time. In most cases, the loan agreement refers to this reset time.
To put it simply, the banks may wait until the reset period to make modifications to your EMIs. The better it is when the rate is dropped, the shorter the reset period.
Repo rate linked loans
Banks delay passing on the benefits under the MCLR scheme. Banks have begun providing loans, nevertheless, that are closely correlated with the repo rate set by the RBI. Your EMIs are adjust proportionately when the rate is changed.
Given the wide range of possibilities, it is always wiser to pick a loan vendor carefully. Before choosing the best choice, homebuyers are advise to conduct in-depth research and comparisons.
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