Living under your own roof or home offers a place to dwell and buying a home also comes with other benefits such as the value of the property appreciates with time. Many of us avail home loans to build or buy that home that you have always wanted. Home loans have become cheaper in recent times, thanks to a drop in the interest rate.
One of the reasons why home loan interest rates are declining is because the change base rate to the Marginal Cost of Funds based Lending Rate (MCLR) has led to the fall in interest rates on housing loans. This new method was introduced by the Reserve Bank of India (RBI) from 1 April 2016, under which all banks in India follow or lend loans based on the MCLRs.
MCLR refers to the minimum interest rate of a bank below which it cannot extend a loan. This rate is an internal benchmark for the bank. It describes the method by which the bank calculates the interest rate offered to an applicant. This is based on the marginal cost of funds, tenor premium, the cost to maintain the cash reserve ration and other operating costs.
To understand MCLR better, it’s essential to understand what the base rate on the home loan is, which was in place before MCLR was introduced. The base rate is the minimum interest rate a bank levies a customer who wants a loan. No bank can offer loans below the base rate.
Since banks shifted from base rate to MCLR from April 2016, the latter has become the benchmark lending rate at which banks offer loans. With the MCLR much lower than the base rate, home loans have become cheaper.
How is MCLR Calculated?
To learn how MCLR is calculated, you need to understand what marginal cost of funds, tenor premium, costs of maintaining cash reserve ratio and operating costs.
- Marginal cost of funds: Sometimes banks borrow funds to meet their business expenses and pay interest on these funds is known as the cost of funds. Marginal cost is the additional expenses banks incur to fund investments or an asset.
- Tenor Premium:it’s the amount of time left to repay the loan. Various loans have several tenures or time periods. If the bank, under MCLR, extends a loan with a higher tenor, then there’s a lot of risks involved. To make up for the risk, banks charge a tenor premium.
- Cost of Maintaining the Cash Reserve Ratio: Banks, as per RBI guidelines, must maintain a certain percentage of their total deposits with RBI in current accounts. This percentage of deposits is called Cash Reserve Ratio (CRR).
- Operating Expenses or Costs:Apart from the services charges, banks incur expenses in extending the loan to you. These expenses are known as Operating Costs or Expenses.
So, Does MCLR Make Home Loan Cheaper?
MCLR is offered in six or one-year options, which are the benchmark rate on floating interest rate loans. If you choose a one-year MCLR, then your home loan rates will be revised every year. Banks are extending home loans at lower floating interest rates and now is the time to switch or choose an MCLR based home loan. It may be noted that you need to consider the costs of loan transfer if you are transferring your home loan from a fixed rate to a floating interest rate.
However, do watch out after moving to MCLR based loans, there’s always the risk of an incline in the movement of the interest rate before you reach the revision period. If the RBI hikes the repo rate, the rate at which it lends money to banks, MCLR too will increase accordingly. Also, ensure that under the MCLR based home loan, you have the option to pre-close or part pay the loan amount or transferring the loan to another lender does not attract heavy penalties.
MCLR does make home loan cheaper if interest rates are declining. So, take the right decision which suits your requirement and not go by what the market reflects about MCLR.