Cheaper Loans – Mumkin Hai?

It was just another day at office and I walked out to the regular darshini (self-service restaurant) for lunch. While I was relishing my paneer fried rice, I overheard a conversation between two colleagues. They were talking about repo-linked loans. They were discussing about ‘a new rule’ because of which home loans and car loans will become cheaper. They were all praise for RBI for implementing this rule and one even went on to say ‘Modi hai to Mumkin hai’. But will your loan actually become cheaper? Will your EMI reduce? Will it benefit the customers? In the next few paragraphs, I will explain what this new rule is and how it will affect you.

What is repo-linked loan?

Repo-linked loan is a loan whose interest rate is based on the repo rate. For starters, repo rate is the rate at which RBI lends to other banks to meet their short-term obligations. RBI reviews this rate every two months and has the authority to change this rate depending upon economic conditions and inflation. The current repo rate is 5.4%. To know more about repo rate, click here.

RBI has been making efforts for banks to move to repo-linked loans since last few months and has finally issued a circular making it mandatory for all banks to offer home and auto loans based on repo rates from 1st October 2019.

How is this loan different from what is in offer currently?

Currently, all loan rates are calculated based on Marginal Cost of Lending Rate (MCLR). MCLR is a rate below which the bank cannot lend to any customer. This rate is arrived at by considering various factors including cost of borrowing for the bank. This rate is calculated internally by the bank. This is where the difference lies. While the MCLR is calculated by the bank and any change made to it is purely the decision of the bank, the new repo-linked loan rates will have to change automatically as and when RBI changes repo rates.

Why is there a need for these loans?

Under the current MCLR based loans, the banks never passed on the complete benefits of rate cuts by RBI to the customers. This resulted in better profit margins for the banks while the customers never got the benefits of lower cost of loans. There have been instances when RBI has expressed its displeasure about this. One such instance can be found here.

Is the new loan better than the previous one?

The answer is yes. The repo-linked loan brings about the much-needed transparency in movement of lending rates. Take for instance the current home loan rate of SBI is repo plus 2.25%. This means the interest rate on the loan will be repo plus 2.25% throughout the tenure of the loan. With current repo rate being 5.4%, the home loan rate is 7.65%. Of course, this is the lowest rate and there will be added margin to factor in loan duration, size and creditworthiness of the borrower.

Can I shift my existing loan to the new structure?

Yes, you can. If your bank has not already started offering repo-linked loans, it will offer one in the next few days. You need to understand the charges involved in shifting to the new structure and calculate the effective savings on interest due to the switch. Make a decision only after evaluating the net savings!

My loan is with LIC Housing Finance. Can I also avail this benefit?

Unfortunately No. Currently, RBI has only made it mandatory for banks to offer these loans. All NBFC’s including the likes of HDFC, PNB Housing Finance, Indiabulls Housing Finance etc. have no obligation to offer repo-linked loans. You can only hope to see such loans from your lender or choose to move to a bank. Remember, shifting a house loan will have costs such as processing fee, legal fee etc. Evaluate your net savings carefully before arriving at a decision.

Is there a catch?

Not exactly a catch, but something that you might not factor. Currently, interest rates are on a downward trend and are expected to remain so for some more time. Hence your loan rates might come down further in the coming months. But do brace up for a situation in the future where interest rates move up. Let higher interest rates not result in a shock.

If you have any question that has not been answered above, please do leave the question as a comment and I will be happy to answer. To know about our various services, click here.

Posted by Alok Chhajer

10 comments

Jayachandrasai

How about NBFC ? What is the impact on Listed financial services ?

Alok Chhajer

Thanks for the interesting question Jayachandrasai. There are a few things to consider here. Firstly, the profile of NBFC customers is a little different from those who take loans from the bank. So there is no immediate significant threat to the NBFC business. However, with the difference between the bank rates and NBFC rates widening due to the repo linked loans, there will be pressure on NBFCs to reduce the rates. It is also possible that some NBFC offer repo linked loan as a differentiated offering to attract customers. Overall, it is definitely a very exciting yet competitive time ahead for NBFCs.

Vikram kothari

Depicts intense research and clear vision of the author of this blog.
All the best Dr Alok chhajed

Alok Chhajer

Thank you Vikram for the positive words. Your feedback is highly appreciated.

Good article Alok…

Alok Chhajer

Thank you Pradeep.

Madan Barmecha

Very nice information.

Alok Chhajer

Thank you!!

Nandita Nadig

very simply put and informative ! Thank you Alok Sir

Asish Bothra

Another interesting and relevant article sir 🙂 The timing couldn’t be any better 👌👌

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