If you are planning to buy a new home or vehicle this festive season, your EMIs could get cheaper due to the external benchmark linked interest rates that banks have begun to roll out for retail borrowers and micro and small enterprises.

The move follows the Reserve Bank of India directive that all banks should introduce external benchmark linked loans for floating rate loans to retail, personal and micro, small and medium enterprises (MSME) borrowers from October 1.

Read more:RBI asks banks to link interest rates to external benchmark

The loans can be linked either to the RBI policy repo rate, Government of India three months or six months Treasury Bill yield or any other benchmark market interest rate published by the Financial Benchmarks India Private Ltd.

Most banks have chosen to link their rates to the repo rate which is currently at 5.4 per cent. With the RBI expected to cut the rates by another 25 basis points, interest rates could further reduce.

Also read:RBI likely to reduce repo rates by 25 bps on October 4

State Bank of India was the first lender to announce that it will adopt repo rate as the external benchmark for all floating rate loans for MSME, home and retail loans, from October 1, 2019.

Related news:From October 1, all SBI floating rate loans to be linked to repo rate

The bank will charge 265 basis points spread above the current repo rate of 5.4 per cent, meaning an effective benchmark rate of 8.05 per cent.  According to its website, home loans up to Rs 30 lakh will have an effective rate of 8.20 per cent for salaried employees, while loans between Rs 30 lakh and Rs 75 lakh will have an effective rate of 8.45 per cent and loans above Rs 75 lakh will have a rate of 8.55 per cent.

In contrast, SBI’s MCLR linked home loan had an interest rate between 8.3 per cent for (upto Rs 30 lakh) to 8.65 per cent (above Rs 1 crore). Other lenders like Canara Bank, Corporation Bank and Indian Overseas Bank (IOB) have also introduced such loans.

“Under this new bench mark, housing loans will be available at cheaper Interest rates.  In addition to housing loans, other retail loans like vehicle, education and clean loans as well as MSEs will also be available at cheaper interest rates,” IOB said in a statement, adding that the new benchmark Repo Linked Lending Rate is fixed at repo rate +2.85  per cent (8.25 per cent at present).

Private sector lenders are also likely to announce the fresh rates soon. On Tuesday, Fincare Small Finance Bank announced a 25 basis point cut in its interest rate for micro loans.

Experts point out that the repo-rate or other external benchmark linked loans will have faster transmission of changes than MCLR based loans.

Should existing borrowers switch?

Existing borrowers can either continue with their existing rate setting regime till the repayment or renewal of their loans. Alternatively, they can switch to external benchmark linked rates without incurring any charges or fees, except some administrative and legal costs.

“These external benchmark linked loans will also ensure higher transparency and more certainty for the borrowers in anticipating the interest rates on their loans. However, on the flip side, the same swiftness in transmission of broader market or policy rate changes can also work against the borrowers during rising interest rate regime, as their interest rates will increase faster in comparison to the MCLR-based loans,” noted Ratan Chaudhary - Head of Home Loans, PaisaBazaar.com.

He also pointed out that before switching to external benchmark linked loans, existing borrowers should remember that the volatility of these loans’ rates would be much higher than MCLR-based ones. “MCLR based loans are reset at least once in a year but those linked to external benchmarks have to be reset at least once in three months,” he said.

"The new external benchmark linked system could prove beneficial to existing borrowers who are on a floating rate loan. But such loans are only available for mortgages and home loans. Others who have two wheeler or personal loans, may not see much benefit,” said Anuj Kacker, co-founder and COO, MoneyTap.

According to a report by ICICI Securities, SBI and other PSU banks in the housing sector, were setting the “floor” for the prime salaried home loans with about 40 per cent market share. “.. the change in MCLR rates and therefore, the reset in home loan rates were less volatile and more measured. Under the new “external benchmark linked” regime, frequency of resets would be higher (every three months),” it pointed out.

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