Home Truths. Changing times for home loan borrowers

Home loan borrowers now have a new benchmark rate to keep track of. The lending rate based on marginal cost of funds (MCLR) will now replace the erstwhile base rate. If you plan to take a floating rate home loan, your lending rate will now be pegged against the MCLR.

While only loans taken after April 1 will be priced against the MCLR, the new norms have implications for existing borrowers as well. This is because most leading banks have set their home loan rates based on MCLR lower than the existing rates.

As an old borrower, you have a choice to move to the new rate system. But before you take the plunge, here are a few things you need to take cognizance of. .

If you have taken a floating rate loan, you know that banks charge you interest with a mark up on the base rate, which is also called spread.

Under the new norms, banks will add a spread to the MCLR instead of the base rate, to arrive at the loan rate. Each bank will now declare at least five MCLRs of various tenures ranging from overnight to one year. This is a marked deviation from the single base rate that banks declared earlier. Longer-term home loans (of most banks) will be priced against the one-year MCLR and hence it is this rate that you need to keep a tab on. Second, since the MCLR will use the latest rates offered on deposits for its computation, it will fall more sharply than the base rate, in a falling rate cycle. Most banks have set their one-year MCLR 10-30 basis points lower than their existing base rates.

The recent 25-basis-point repo rate cut by the RBI and the possibility of another one during the year, can lead to a quicker fall in the MCLR. Hence, it would be wise for existing borrowers to move to the MCLR-based loan rates, as they would benefit more in a falling rate cycle, as is the case now..

Third, you need to remember that a lower MCLR may not fetch you lower lending rates, automatically, with all banks, as there is the ‘spread’ factor to consider. Bank of Baroda, for instance, set its one-year MCLR at 9.25 per cent, 40 basis points lower than its base rate of 9.65 per cent.

Does this mean that borrowers moving to MCLR will see home loan rates fall by 40 basis points? Not quite. This is because the bank has added 35 basis points spread (‘strategic premium’) to its MCLR; home loans are hence priced at 9.6 per cent.

This is only 5 basis points lower than the rate charged under the base rate system.

But a few banks do offer better deals under the MCLR. SBI, for instance, has set its one-year MCLR 10 basis points lower than its current base rate.

New borrowers (under the MCLR) will be charged 9.45 per cent rate on their home loans against the 9.55 per cent for old borrowers (under base rate). ICICI Bank, too, has priced its home loan 20 basis points lower under the MCLR at 9.45 per cent.

If you find better deals under the MCLR, you have two options. One, you can switch from base rate to MCLR-based loan pricing within the same bank. Normally, when you try to reset your interest rate within the same bank, the bank will usually charge a conversion fee. However, moving from base rate to MCLR does not entail any additional cost. Thus, you should make the switch irrespective of the quantum of interest savings.

Let us assume that you have an outstanding home loan of ₹60 lakh for a remaining tenure of 15 years from SBI at 9.55 per cent. Your EMI works out to ₹62,835.

If you switch to the MCLR-based rate of 9.45 per cent, your EMI will reduce by about ₹360 per month. Over the entire term of the loan, your savings will be sizeable — about ₹65,000. Since the switch does not involve any cost, it will be wise to move to the new system.

The second option that you have is to move from one bank to another. This may gain more importance now, as banks are likely to compete more aggressively under the MCLR.

Remember though that in this case, you have to foreclose your loan, and then approach a new bank for a fresh loan. Here, banks charge a processing fee, which ranges from 0.5 to 1 per cent of the loan.

Some banks do offer waivers but, before making the final decision, you need to consider if switching will still be beneficial after all the costs involved.

COMMENT NOW