Borrowers of repo-linked home loans are able to benefit from the cut in interest rates from the month after the RBI’s monetary policy announcement.
Here’s a home loan scheme that links interest rates to an external benchmark, the repo—set and declared by the Reserve Bank of India (RBI) in its bi-monthly monetary policy review. State Bank of India (SBI) was the first to launch a repo-rate linked home loan scheme, effective July 2019. So, in case of a change in policy repo rate, the repo linked lending rate changes from first day of the following month, which is a very effective move for borrowers.
Following SBI’s foot-steps, Bank of Baroda too introduced a repo-rate linked home loan scheme from August 12. Other public sector banks are likely to follow suit soon.
Raj Khosla, Managing Director and Founder, MyMoneyMantra says, “Repo-rate linked home loan scheme is transparent compared to existing loans linked to marginal-cost-of-fund based lending rate (MCLR). The interest rates on loans will change upwards or downwards in line with the movement of the repo rate announced by RBI.”
Why offer a repo rate linked home loan?
Transmission of rates was a major concern by the RBI. The banks were not passing the benefit of rate cut by RBI to borrowers. For instance, the one-year MCLR rates offered by SBI in October 2018 and August 2019 were 8.5 per cent and 8.25 per cent, respectively. Similarly, ICICI Bank’s one-year MCLR remained unchanged at 8.65 per cent from October 2018 to August 2019.
However, in this period, the repo rate has been cut from 6.5 per cent to 5.4 per cent by the RBI. Clearly, banks have been slow in passing the benefits of rate cuts to borrowers.
In the December 2018 monetary policy meet, the RBI asked banks to link all floating rate retail loan products to external benchmarks starting April 2019.
The RBI had stated that banks should benchmark the rates to either the RBI policy repo rate or Government of India’s 91-day or 182-day Treasury bill yields as developed by the Financial Benchmarks India Private Ltd (FBIL) or any other external benchmark developed by the FBIL.
However, during the consultations with the RBI, several banks opposed the decision of linking lending rates to an external benchmark, indicating that their cost of funds was not linked to those external benchmarks and delayed the implementation indefinitely. However, there is still no official announcement on this development from the RBI. Even so, a couple of banks have introduced the repo rate linked home loan scheme.
What is it about?
Earlier, floating rate home loan borrowers had only one option—loans linked to marginal cost of fund based lending rate (MCLR). But now, they can take a home loan linked to the repo rate or MCLR.
To be eligible for the SBI repo rate linked home loan scheme, the borrower should have minimum annual income of Rs 6 lakh. The tenure of the loan is up to 33 years. In the case of under-construction projects, the maximum moratorium period up to two years is offered over and above maximum loan tenor of 33 years. So, in such cases the total loan tenure cannot exceed 35 years.
In this home loan scheme, the borrower needs to repay a minimum of 3 per cent of the principal loan amount every year in equated monthly installments. If you take a home loan of Rs 50 lakh, you need to repay a minimum of Rs 1.50 lakh as principal plus the interest cost every year.
The interest rates in this scheme are not directly linked with the repo rate figure announced by the RBI. The loan rate is 2.25 percentage points above the repo rate. On July 1, the repo rate was 5.75 per cent, so repo-linked lending rate is 8 per cent (2.25 + 5.75). But, the repo-linked lending rate may change effective September 1 as we had a repo rate cut of 35 basis points (bps) announced by the RBI this month. Hundred basis points equal one percentage point.
At present, we will take the repo-linked lending rate as 8 per cent. Over and above the repo-linked lending rate, these banks maintain a spread of 40 bps to 55 bps. So, the effective rate for home loans up to Rs 75 lakh ranges from 8.4 per cent to 8.55 per cent. The bank charges a premium of 20 bps on the interest rate if the loan-to-value ratio is more than 80 per cent. For home loans above Rs 75 lakh, the effective rate is 8.95 per cent to 9.10 per cent (i.e. spread of 95 bps and 110 bps on repo linked lending rate of 8 per cent). Effective August 10, home loan rates linked to MCLR would be 8.6 per cent to 8.85 per cent at SBI, which is more than the repo-linked rate.
Similarly, for Bank of Baroda MCLR linked home loan rate starts at 8.45 per cent, while the repo-linked rate starts at 8.35 per cent. At present it’s 5 bps cheaper than SBI’s repo-linked home loan scheme.
Gautam Bhasin, Founder of Prospurts, an online wealth management firm says, “Repo rate linked home loan scheme will be beneficial to borrowers with immediate savings when interest rate goes down.” For instance, with further 50 bps rate cut as expected in the next one year, there will be further savings for borrowers on interest (refer to table).
Apart from interest rates, there are additional costs for borrowers opting for a repo-linked home loan scheme. For instance, SBI charges a processing fees of 0.35 per cent of the loan amount plus service tax. The minimum fees will be Rs 2,000 and the maximum is Rs 10,000 plus service taxes. These charges may vary with banks.
There has been a delay in transmission of rate cut by banks linking loans with MCLR. But now, there are better options. Khosla, says, “In a repo-linked home loan scheme, borrowers don’t need to wait for banks to revise the MCLR rate, which will lead to a change in the effective interest rates of home loan when a rate cut is announced by RBI.”
The borrowers of repo-linked home loans are able to benefit from the rate cut in interest rates in the following month after the RBI monetary policy announcement.
The borrowers also know exactly how interest rates charged are arrived at by the bank.
Now, borrowers will be in dilemma whether to choose a home loan scheme linked to the repo rate or MCLR. SBI’s repo-linked home loan scheme has an interest rate of 8.4 per cent to 8.55 per cent, while the MCLR-based option charges 8.6 per cent to 8.85 per cent. Clearly, interest rates are lower for repo linked home loans.
In this scheme, borrowers need to be prepared for volatility in their tenure or EMIs due to the nature of the scheme. There are several borrowers who are not prepared for this concept of volatility in EMI.
Gaurav Gupta, co-founder and CEO of MyLoanCare.in says, “In this scheme, borrowers also need to be prepared for a hefty increase in interest rates in case RBI increases repo rates due to economy factors.” In MCLR-linked home loans, banks have reset clauses of six months or one year, whereas in a repo-linked scheme it’s effective from the following month after the RBI monetary policy announcement.
Besides, SBI wants borrowers to have a minimum annual income of Rs 6 lakh to be eligible. Gupta says, “Due to such annual income cap, a large part of the market is not be able to avail benefits of this scheme. At present, the borrowing is mainly happening in the affordable housing segment and Pradhan Mantri Awas Yojana (PMAY) scheme, wherein the income of the borrower is less than Rs 6 lakh per annum.”
Additionally, SBI charges a premium of 20 bps on the interest rate if the loan-to-value ratio is more than 80 per cent, which increases the borrowing cost. Banks also take into consideration the credit score of borrowers, so interest rate could end up at the upper-end of the range and further increase the borrowing cost.
With its features, the repo rate linked scheme is primarily targeted at borrowers in tier I, tier II and tier III cities. Also, loans are available only to borrowers with a steady income above Rs 6 lakh per annum in SBI’s case.
The loan linked to repo rate is 10-30 bps cheaper compared to the MCLR linked home loan scheme. So, in the long term, you will save on interest costs. If you are able to adapt to volatility in EMIs, consider applying for the repo-linked home loan scheme.