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20 APRIL, 2022
There are two types of home loan interest rates - floating and fixed. While fixed interest rates remain constant for the entire tenure, floating interest rates are based on economic factors, market rates and an index rate. These index or benchmark rates are defined by the Reserve Bank of India and followed by commercial banks. When you avail a home loan, financial institutions keep this benchmark rate as the basis to determine your home loan interest rates. Therefore, it is crucial to understand these benchmark rates.
If you have ever thought of availing a home loan at floating interest rates, you might have come across terms like MCLR (marginal cost of funds based on lending rate), BPLR (Benchmark Prime Lending Rate), Base Rate (BR), and Repo Rate (RR). These are the benchmark rates based on which lenders determine your interest rates.
The Benchmark Prime Lending Rate introduced in 2003 by the Reserve Bank of India (RBI) was the interest rate charged by commercial banks to its customers. An internal benchmark rate, it was used to set the interest rate for home loans. BPLR was calculated based on the average cost of funds. However, BPLR lacked transparency as lenders could lend below it to some privileged customers. So, in 2010, the Reserve Bank of India introduced the Base Rate system, which replaced the BPLR system
The Base Rate was the minimum interest rate at which Indian banks could lend. They were not permitted to resort to any lending below this rate The base rate was determined significantly on the average cost of funds. As per RBI policies, lenders were required to review their base rate at least once every quarter. MCLR was introduced in April 2016 by RBI in place of base rate.
The Marginal Cost Lending rate is the minimum rate below which banks cannot lend. It is an internal rate fixed by individual banks for floating loans. The MCLR is linked to the marginal cost of funds, operating costs, cost of carrying in cash reserve ratio and tenure premium. It is determined based on the current cost of funds as opposed to the base rate which is based on the average cost of funds. MCLR is also more responsive to changes in policy rates. However, there was still a lack of transparency in the home loan interest rates for customers.
Lastly, the RBI introduced a new method of external benchmark-based lending rates to increase transparency. Under this, banks were instructed to link their lending rates on an external benchmark such as the repo rate, three-month treasury bill or six-month treasury bill. Most of the lenders opted for repo rate to link their lending rates. It offers more transparency in the system and borrowers know that whenever RBI raises or lowers the repo rate, their interest rate will also change.
Whenever there is a change in any benchmark rate, borrowers have the right to switch to the new rate or stick to the old one. If needed, you must assess your savings by each rate type and then decide. You could also take an expert’s assistance to make the right decision.
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