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Will Home Loan Interest Rates go Down in Future?

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On 7th August 2019, the Reserve Bank of India has cut down the repo rate from 5.75% to 5.4%. This was the fourth time that RBI reduced the repo rate this year. This cut down is intended to support the growth of the economy. This could also give a boost to PMAY, a scheme introduced to promote affordable housing in our country.

The reduced repo rate is good news for borrowers that their EMIs are likely to reduce presuming that the lenders will pass on this benefit to them. Before understanding how the repo rate can affect your home loan interest rates and eventually EMIs, knowing the relation between repo rate and EMIs is important. For this, we first need to understand, what is repo rate?

In case of funds shortage, all commercial banks borrow money from the Reserve Bank of India. The interest rate at which the RBI lends money to these banks is called a repo rate. Monetary authorities use the repo rate as a tool to control inflation. When there is a drop in inflation, RBI reduces the repo rate to encourage banks to borrow funds. These banks eventually provide the funds to their customers, thereby increasing the supply of money.

The effect of repo rate on EMIs

Ideally, a reduction in repo rate should result in low-cost loans for borrowers. When RBI cuts down the repo rate, banks are expected to reduce the interest rates they charge on loans. The lower interest rates eventually decrease the EMIs.  However, it was observed that banks took time to pass on the benefit of lower interest rate to their customers. That is why the RBI incorporated the Marginal Cost of funds based Lending Rate (MCLR) system to change this scenario. After MCLR, banks are obliged to pass on the benefit of changing repo rates to their customers. In a way, the MCLR system has strengthened the relationship between the repo rate and the EMI.

Here is how repo rate cut will affect different types of borrowers:

Currently, all home loans are linked to MCLR. In this case, the EMIs will reduce only when the bank will decrease its MCLR. Moreover, borrowers will get the benefit of repo rate cut at the time of the reset date of their home loans. Generally, a reset period of six months or one year is offered by banks. When you reach your reset date, the upcoming EMIs are re-calculated based on the interest rates on that day (reset date).

With the RBI slashing repo rate, borrowers are anticipating a reduction in EMIs. However, it will take some time for them to get this benefit. The underlying reason for this is that home loans with floating interest rates on given MCLR, and MCLR does not reduce consistently with the repo rate. There are various factors like the cost of the deposit, operating cost, etc. are included while calculating MCLR.

Furthermore, the home loans are linked to the reset date on which the new rate is applied. Reset is more likely to happen once in a year. So, despite bank reducing MCLR, the reduction can be observed in loan from the next reset date.

In conclusion, home loan interest rates will go down after cut down of the repo rate, but the effect will not be as significant as anticipated.

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