How MCLR will Affect your Home Loan Interest Rate?

The base rate system was introduced by the Reserve Bank of India in July 2010.Based on this, banks and NBFCs were not allowed to lend below a certain threshold, to ensure that change in interest rate was effectively transmitted to customers. However, banks and NBFCs adopted various other methods to calculate their cost of funds. Due to this, policy transmission from bank to customer became somewhat ineffective. 

 The base rate system was replaced with MCLR (Marginal Cost Of Funds), based on the lending rates of April 2016. MCLR is the standard lending rate at which lending institutions offer money to borrowers after March 31st, 2016. Unlike the old base rate system, it is linked to actual deposit rates. Every bank and NBFC has to submit at least five reset clauses or MCLR rates to the RBI for specific periods of time—one year, six months, three months, one month, and overnight. So, how does MCLR affect Home Loan interest rates? What is the difference between MLCR and base rate? Read on to find out. 

Difference between MCLR and Base Rate

The difference between the two lies in the method of their calculation. When calculating the base rate, the main components used are:

• Operating expenses of the bank or NBFC
• Cost of funds, which is the interest rate offered by the bank or NBFC on deposits
• Cost involved in maintaining the cash reserve ratio (CRR)
• Margin of profit or minimum rate of return

This means when using the base rate, banks and NBFCs don’t consider the repo rate and depend primarily on deposits and the composition of Current Accounts and Saving Accounts (CASA). Even today, many banks and NBFCs use average cost of fund calculation. This means any increase or decrease in key rates—such as repo rates—don’t get transmitted directly to the customer.

 However, it has become mandatory for all banks and NBFCs to include repo rate for MCLR calculation. The main components of MCLR are:

• Cost involved in maintaining CRR
• Operating costs
• Marginal cost of funds
• Tenure premium

The marginal cost of fund is based on the cost of borrowing—both short-term borrowing rates (repo rates) and long-term borrowing rates. It is also based on the return on net worth. It’s calculated after considering the lending rates on current, savings, and term deposit accounts.

Obviously, the marginal cost of funds and tenor premium are the key differences between their calculation. Marginal cost of funds has a higher weightage while calculating MCLR. Any changes in the repo rate has a direct effect on the marginal cost of funds. Due to this, banks and NBFCs are required to change the MCLR immediately.

Will MCLR Affect all Kinds of Loans?

No, MCLR is linked to loans with floating rate of interest only. So, if you have a Home Loan under a fixed interest scheme, MCLR will not affect your loan in any way.

All floating interest rate loans are now linked to the MCLR, and whether you stand to lose or gain depends on the change in repo rate. MCLR is beneficial to customers only when the interest rate cycle follows a downward trend. However, it is important to understand that lending rate will not stay low forever. When the trend gets reversed, the hike will be swift.

If you already have a Home Loan in your name and if you’re planning to repay it in the next few years, shifting to MCLR could be beneficial to you. Consider using the Home Loan EMI calculator to calculate the actual benefits you stand to gain before making a decision.