Recently, when large commercial banks reduced their interest rates on home loans by 25-30 basis points (bps), the underlying lending rates remained unchanged. One basis point is one hundredth of a percentage point. In the process, more banks have started linking home loan rates to 6-month marginal cost of funds based lending rate (MCLR). Here is what you should know about these rates as a borrower.
Lending rate
When you decide to take a home loan, know that the interest rate on a home loan is not the same as the benchmark lending rate offered by banks. From April 2016, MCLR is the benchmark lending rate for new borrowers. All new floating rate home loans offered by banks are now linked to an MCLR.
Prior to April 2016, all floating rate home loans were linked to the base rate. Base rate had only one rate for each bank. But when MCLR came into effect, banks had to set at least five MCLR rates: overnight, 1 month, 3 month, 6 month and 1 year. Out of these, banks are using 6-month and 1-year MCLRs for providing home loans to their customers.
For instance, recently when ICICI Bank Ltd, one of the country’s largest private sector banks, reduced the interest rate on its home loans, it gave borrowers two options to choose from—1-year- and 6-month-linked MCLRs.
1-year or 6-month?
Banks such as State Bank of India have linked home loans to 1-year MCLR.
On the other hand, Kotak Mahindra Bank Ltd and now ICICI Bank are offering home loans linked to 6-month MCLRs. What does this mean?
The main difference between these two sets of MCLRs is the reset duration.
If you are on a 6-month MCLR, your home loan will get reset in 6 months and in case of 1-year MCLR, it will get reset in 1 year. Trying to choose between the two is not easy, largely because you cannot time the market.
Experts say that one should opt for a shorter MCLR durations in the current scenario, that is, in a falling interest-rate regime.
What should you do
As a borrower, from here on there is one more component that you have to factor in before taking home loans. To know whether the rates will go up or down is anybody’s guess. However, what you can do is decide based on the final home loan interest rate that you get from your bank. Every home loan comes with a spread, basically a mark-up on the MCLR.
In the case of ICICI Bank, where it offers both the options to home loan borrowers, the final home loan rate is the same. Though ICICI Bank’s 6-month MCLR is at 8.15% and 1-year MCLR is at 8.20%, in both cases the home loan interest rate is at 8.35-8.40% for salaried borrowers for amount of up to Rs30 lakh. If there is no difference in the final home loan rate you get, you can pick any of the MCLRs. Also there is only a marginal difference of 5-10 bps in the underlying lending rates.
Now suppose you end up opting for an interest rate which then tends to increase over time, you still have the option to switch loans to another bank if you are on floating rate loan.