What is a Repo Rate and how it matters wrt Home loan interest rates?

Repo rate is the rate of interest at which banks borrow money from the RBI. When the RBI cuts the repo rate money is available with the banks at a lesser cost and this in turn keeps the lending rate on a lower end.  A measure of a bank's cost of funds is MCLR ( Marginal Cost of Funds based Lending Rate). To understand it in a simpler way, keeping other factors constant, a cut in the repo rate by RBI will mean MCLR of bank falling which in turn leads to low home loan interest rate and vice versa. 

Current scenario of NBFCs (Non Banking Financial companies) in the real estate sector:

Over the last three financial years, the share of housing and commercial real estate in NBFC lending has suddenly gone up, especially with banks backing down on this sector. Affordable housing is benefitting by the existence of NBFCs. It is easier for a person to seek home loans of smaller amount and invest in NBFCs are significantly dependant on External Commercial Borrowings (ECBs) for funding these days. 

Backstory of why A Repo Rate Cut is currently essential in a real estate market: NBFC fund crunch impact on the real estate sector 

Since April 2016, all loans sanctioned by banks including home loans, are linked to the bank’s MCLR. A lower MCLR will effectively mean a lower interest rate and, thereby, a low-interest burden, keeping in mind that the other factors remain constant. A cut in bank’s MCLR benefits all home loan borrowers. This rate cut will have a direct impact on the real estate sector, provided the banks, in turn, transmit the same by a corresponding reduction in lending rates to those seeking home loans. 

Much earlier, the RBI had proposed that all new floating rate personal or retail loans (housing, auto, etc.) extended by banks from April 1, 2019, is to be benchmarked to an external benchmark such as repo rate, T-bill yield etc. The move was seen as an attempt to align lending rates to policy rates. However, even in this new mode, the lending is still linked to an internal benchmark. Lastly, RBI came out with a statement that further consultation with stakeholders is required and hence the approach to link lending rates to an external benchmark was put on hold.

Banks declare their MCLR each month but monthly changes in the MCLR is not accounted for in the case of home loans of an existing borrower. MCLR linked home loan interest rate is reset every 12 months ( 6 months for some banks) and hence for a borrower the MCLR of the bank after every 12 months from the date of starting of the home loan matters. For example, if you had taken a loan in October 2018 when the bank’s MCLR was 8.35 per cent, in October 2019, the home loan rate of interest will be reset based on bank’s MCLR in October 2019.

For example, Let us see the impact of a 1 per cent fall in the home loan interest rate. 

I.) At a home loan rate of 9 per cent, the EMI on Rs 1 lakh loan for 20 years 

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At a home loan rate of 8 per cent, the EMI on Rs 1 lakh loan for 20 years 

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Similarly, On a Rs 50 lakh, the total interest paid over 20 years at 9 per cent and 8 per cent will be Rs 57,96,712 lakh and Rs 50,37,280 lakh respectively, almost Rs 7.5 lakh less of interest. This shows, paying even a one percent lower rate can save a lot of money for you.

The Reserve Bank of India (RBI) last week reduced the repo rate for the fourth time this year as benign inflation provides the central bank room to help an economy that is growing at its slowest in nearly five years. The RBI's monetary policy committee, led by Governor Shaktikanta Das, lowered the repo rate by 35% basis points to 5.4%.

Following SBI suit, more Public Sector Banks (PSUs) have announced linking their lending and deposit rates to the Reserve Bank of India's (RBI) repo rate to enable faster transmission.

The PSU banks which have announced the decision are Syndicate Bank, Bank of India, Union Bank and Allahabad Bank. While, Syndicate Bank made the announcement on Friday to link its deposits and loans to the repo rate, Bank of India, Union Bank and Allahabad Bank also declared that they are undertaking the arrangements to facilitate the launch of similar products. 

With the RBI deferring the decision to link all new floating rate personal or retail loans (housing, auto, etc.) to external benchmarks like the repo rate, things are unlikely to improve in a hurry. Also, existing home loan customers may have to wait awhile to see an impact on their EMIs because of the reset date factor. The interest rate of the loan for the borrower is changed only on the reset period, which is typically 1 year. So your loan rate will go down only after twelve months even if your bank reduces the MCLR rate today. Do not merely look at the bank’s MCLR but know the actual home loan interest rate before finalizing the deal. Bank’s are allowed to charge a Mark-Up on the MCLR before disbursing the loan. Finally, make a pre-payment to repay the home loan as soon as possible and own your home with 100 percent equity of your own.