Buying a home for yourself might be one of the biggest life decisions and one of the most financially draining ones as well. If you have decided on the property and determined your budget, getting a loan is one of the first things you need to be concerned about. The last two repo rate cuts have raised hopes for prospective home buyers planning to borrow and for existing home loan borrowers. It is, however, important to understand whether the latest repo rate cuts actually resulted in lower interest cost for borrowers.
What is repo rate?
While thinking of getting a loan, the prevailing trend in repo rates is an important indicator in determining how heavy your loan will be on your pocket. Repo rate or repurchase rate is the interest rate which RBI charges on the money it lends to other banks. In other words, it is the rate at which banks borrow money from the RBI by selling their surplus government securities to the central bank (RBI). The central bank changes rate as per the demand-supply situation for funds in the banking system. Repo rate movements define the benchmark MCLR rate of banks for various loans and hence, the interest cost for current and prospective buyers.
Unlike last year, which witnessed multiple rate hikes by RBI's monetary policy committee, 2019 has already seen two consecutive cuts in the repo rate. Both the cuts have brought down the repo rate to 6% with 25 basis points cut each in February and April.
In an ideal situation, this should eventually have a trickle-down effect on rate at which banks lend, and hence, there is an expectation of rate cut across loan products. Since realty and auto sectors are most rates sensitive, these cuts are expected to give a major boost to loans taken for buying homes or automobiles. Floating rate home loan interest rates are benchmarked to MCLR that should move in direct proportion to changes in repo rates. So it is only fair to expect some relief from the high-interest rates.
Are loans now cheaper?
Even as there were high expectations in the market that repo rate cut will result in banks reducing their MCLR, in reality the MCLR rate cuts have been marginal. The reason lies in the structure of funds for banks in India. Banks are significantly dependent on deposits from customers on raising their funds and the interest they pay on these deposits is typically fixed. Overnight funds from RBI directly governed by repo rate form a small fraction of their funding resources. Further, banks cannot afford to reduce their deposit rates as there is a significant competition amongst banks to get a larger share of the deposits. As a result, even as RBI has signalled a lower rate regime, banks' ability to reduce their deposit rates is restricted, which results in lower transmission of policy rates to borrowers.
Look at the last four repo rate changes along with the change in MCLR of few prominent banks (see table)
Form the table we can clearly assess that the decrease in repo rate has not encouraged banks to decrease their MCLR proportionately. When compared to December 2018, the 1-year MCLR rate of all three banks has come down only by 5 bps in April 2019, despite a 50 bps cut in repo rate.
Further, while rate cuts do reduce EMIs for existing home loan customers, they may have to wait a while to see the change. Borrowers can witness the change in the interest rate only on the reset period, which is usually one year. So, even if your bank slashes the MCLR rate today, your loan rate may take up to 12 months to go down, depending on the reset date and the current date.
The repo rate cuts could have been a real welcome in a time when the real estate sector is witnessing stagnation. But the ground reality is that the effective repo rate cut of 50 bps in the last three months has only resulted in about 5-10 bps cut of MCLR for all leading banks. In the current scenario, lower borrowing costs and smaller EMIs continue to be an illusion for borrowers despite a promising signalling of a lower rate regime.
The writer is co-Founder and CEO, Myloancare.in.