- November 24, 2016
- Posted by: admin
- Category: Blogs
After goading banks, without much success, to pass on full benefits of policy rate cuts to borrowers, Governor Raghuram Rajan Tuesday said the Reserve Bank will this week issue guidelines to determine base rates on a new methodology based on the marginal cost of funds.good news for home loan EMI
This could pave way for EMIs on home and auto loans to fall. The base rate, the minimum benchmark rate below which a bank cannot lend, has made it impossible for banks to cheaply price corporate loans and charge more from retail borrowers.
Stating that the marginal cost of pricing makes the costs flow through into lending rates faster, Rajan said that “the intent is that banks would be able to make incremental loans on the marginal cost pricing while historical or legacy loans will be on the base rate. That’s the intent as we go forward.”
As banks held on to higher lending rates even after the central bank had cut the repo rate twice till March this year, RBI in April suggested the marginal cost as the basis for calculating their base rate, much to the chagrin of bankers who said that the domestic market was not mature enough to adopt such a method as deposits are still priced higher.
Let’s see how a fall in rate impacts home loan which is on flexible interest rate :
On Loan Tenure
Assuming the banks pass on the benefit, and home loan rate falls by 0.25 %, the cumulative advantage could be large. Let’ assume, outstanding amount on a home loan is Rs 10 lakh, with 20 years remaining and at an interest rate of 10.50 percent at an EMI of Rs 9,983. If rate falls by 0.25 percent, keeping the EMI constant, the tenure falls by about 13 months.
The immediate and most visible impact is on the EMI’s. Let’s say the EMI on Rs 40-lakh loan for 15 years at 9.50 percent is Rs 41,769. If there is a 0.25 per cent decrease in home loan rate, the EMI falls to Rs 41,168, a savings of Rs 600 a month.
On Interest Burden
The actual impact is visible in the longer term especially in terms of total interest paid. In the example above, the total interest burden on the Rs 40 lakh loan if run till 15-years comes to Rs 35, 18,418. When rate falls by 0.25%, it translates into interest savings of Rs 1, 08,000.
The new benchmark for lending from 1st April is the marginal cost-based lending rate (MCLR) which would replace base rate linked lending in due course of time. Few banks have announced MCLR which is lower than the base-rate linked rate. The reset mechanism of MCLR is more dynamic and most banks would either reset it half-yearly or yearly. The advantage which borrowers failed to get when repo rate was cut is something borrowers can expect from the MCLR mechanism.
Existing borrowers are allowed to move on to the MCLR linked structure however they should wait till things settle and better picture emerge. They anyhow do not have to foreclose ( may require one time fee) and move to the MCLR platform.
good news for home loan EMI