MCLR system dips home loan interest rate

The shift to the MCLR system from the base rate one, say experts, is a beneficial one for home loan borrowers. What does this spell for real estate?

Starting April 1 2016, all nationalised PSUs and private sector banks have adopted the Marginal Cost of funds based Lending Rate (MCLR) as against the base rate funding system, following the RBI's circular date December 17, 2015. This move by the banks, has resulted in a significant fall in the interest rate and the home loan lending rate immediately corrected by 0.3 percent for many banks.

Now, home loan borrowers have many doubts in their minds related to the new interest rate system such as its applicability on the old loans, its impact in the long-term and the necessary steps to switch over from the base rate system to the MCLR system.

"The basic difference between MCLR and the base rate is the consideration of key rates and the tenor premium (time left for the repayment of the loan) while fixing the lending rate costs. So, any cut or increase in rates (especially key rate like the Repo Rate) by the RBI, will now get transmitted to the bank customers immediately. For home loan customers, it is beneficial. Considering the current declining interest rate regime as with the new method, the transmission of the benefit of lowering key rates will be much higher and faster than the base rate system. Top banks have reduced their home loan rates further with the recent cuts in the repo rate by the RBI, post the implementation of the MCLR," says Deepak Joshi, president and chief business officer, Religare Housing Development Finance Corporation Limited.

The details:
Experts point out that the MCLR system is to be computed based on a formula prescribed by the RBI that is primarily based on the weighted average cost of term deposits and borrowings (based on the repo rates released by the RBI from time to time) of the bank's outstanding as on the previous day of the review and also the other components like operative costs, CRR, tenor premium, etc. It should be noted that the MCLR system shall not be applicable to fixed rate loans and where loans are partly on a fixed rate. The same shall not apply to the fixed portion of the loan as well.

The impact of MCLR on interest rate:
"Banks such as the SBI, ICICI, are to be the first ones to introduce the MCLR rate to their home loan customers. If you look at the gap, it is around 15-20 basis points, between the MCLR and base rate for one year term. It is generally said that banks with better matched assets to liability ratio can have a short period reset than others who have a mismatch of their assets to liability ratio. A majority of the big banks is looking at a reset of a 12 month period for MCLR. Unless the gap is higher, it would not make any commercial sense for existing borrowers to move to MCLR," explains Rajiv Raj, co-founder and director Credit Vidya.

The long-term effect:
Going forward, in a falling interest rate scenario, the MCLR system will benefit the customers as the reduction in repo rate will reflect on their interest rates. However, in an ascending interest rate scenario, the customers will have to bear the brunt of the increase in interest rate for their home loans, explain experts.

While the MCLR based interest rate system would apply to all new home loan borrowers, the existing loan borrowers have an option to switch to the MCLR-based interest rate system with a 'mutual agreement with their banks' and on the payment of a fee. The question thus, to be answered is should one opt to shift to the MCLR-based interest rate for their existing loans?

Kalpesh Maroo, partner, BMR and Associates LLP says, '"The answers to the above question will vary in different scenarios and one ought to consider factors such as outstanding loan, remaining tenor of the loan, interest differential, other charges levied by the banks for the switch-over, etc. The MCLR system should facilitate rate cuts provided by the RBI, and pass them down to the consumers and should hence, provide more purchasing power and monetary outflows into the market and consequently, such a move will give a boost to various economic sectors. The interest resets mandated by the RBI, at least once a year, could further benefit the consumers, given that the interest rates are on a downward slope. However, since the future cannot be accurately predicted and the RBI increasing the repo rates cannot be ruled out either, the MCLR system could have an adverse effect when the interest rates are on an uphill and this would be particularly relevant for long-term borrowings."

To switch or not to switch?
Experts suggest that it is not compulsory for existing home loan borrowers to switch to the MCLR system. They can continue with the base rate. However, considering that the declining interest rate regime will continue in the near future, one should switch to the MCLR system as the transmission of benefits of lowering key rates will be much higher and faster than the base rate system, especially if one is planning to pre-pay the loan faster before the reversal of the interest rate cycle. One should also factor in the switch fee, if any, being charged by the banks for the switch.

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