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A Definitive Guide to MCLR Based Home Loans

The Marginal Cost of Funds Based Lending Rate (MCLR) took effect in April 2016 to help borrowers reap the benefits of the Reserve Bank of India’s rate cuts on different types of loans. Since July 2010, the old base rate structure has been in place. The MCLR system replaced it.

The newly implemented MCLR system ensures that your bank cannot charge you lending rates that exceed the margin set by the RBI. This is true regardless of the type of loan, such as a house loan. So what is the impact of MCLR based home loans? The guide below will provide a detailed response to the question.

The Reserve Bank of India and Its Credit Policy

The RBI adjusts interest rates to increase or decrease credit flow in the economy. The economic situation determines this. In the event of inflation, interest rates are raised, and in the event of deflation, rates are lowered to stimulate growth.

In this context, the Repo Rate is a critical tool in the hands of the RBI. The repo rate is the interest rate at which the RBI loans to commercial banks. When the RBI seeks to increase credit flow, it lowers repo rates. Conversely, repo rates are raised to decrease credit flow.

Problem With Base Rate System

Till March 2016, commercial banks used the base rate system as their benchmark for lending to borrowers. In this context, the base rate is the lowest rate set by banks to lend, which cannot be reduced regardless of the loan’s term. However, RBI wants its rate change decisions to be reflected on the ground.

The RBI, on the other hand, desired that rate changes be passed on to end-users. However, the transmission was ineffective. Either bank do not follow suit, or there is a significant time lag.

What is MCLR?

The RBI implemented the Marginal Cost of Fund Based Lending Rate (MCLR) system to replace the base rate. The goal was to quickly pass on the Central Bank’s rate change to end-users. Commercial banks must set different MCLRs for various loan tenures spanning from overnight, quarterly, to yearly and long-term rates.

The Impact of MCLR on Home Loans

Home loans are intended to be long-term investments. Therefore, if a borrower receives a loan based on a yearly MCLR, the rate remains constant for one year regardless of changes in repo rates. However, it will adjust accordingly after a year and be fixed for the following year.

As a result, if a borrower has a house loan based on an annual MCLR and the rates rise, he will not have to pay a higher EMI and will benefit. Similarly, if interest rates are lowered, the borrower will reap the benefits after a year.

Notably, the MCLR will have no effect on fixed-rate housing loans. Moreover, financial institutions must publish the MCLR rates for various tenures. This will help a borrower who can quickly determine his instalment before taking the loan using a housing loan interest calculator.

Should You Switch to MCLR?

Home loan borrowers who took out loans before April 1, 2016, can switch their loans from the base rate to the new MCLR system. If the repo rates are reduced, your EMI will decrease accordingly. However, your EMI may rise if the RBI increases the rates. Furthermore, a borrower must pay conversion fees ranging from 0.5 per cent to 0.6 per cent of the loan amount. As a result, before making a switch, you should calculate the cost of your loan using a housing loan interest calculator.

House loans are for the long term, and borrowers can benefit from rate changes as they occur. In addition, the MCLR system quickly reflects the change, helping the borrower.

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