Cheaper home, auto loans: Why repo-linked loans could benefit in 2-3 months

The Reserve Bank of India (RBI) on Friday announced a 25 basis points (bps) reduction in the repo rate, bringing it down from 6.5% to 6.25%. This move is expected to make home and auto loans more affordable, benefiting borrowers who have loans linked to the repo rate.

 

The last time the RBI made a rate cut was in May 2020, when the repo rate was slashed to 4% to support an economy hit hard by the COVID-19 pandemic. As the economy began to recover, the RBI started increasing rates in May 2022, which peaked at 6.5% by February 2023. Since then, rates have remained unchanged as the RBI balanced concerns over inflation with the need for economic growth. With inflation easing and GDP growth slowing to a four-year low, a rate cut had been anticipated—and it has now arrived. 

Most home loans in India are linked to the repo rate. Banks typically cut their home loan rates in line with a falling repo rate. Though the transmission happens with some lag.

 

So, if you have a floating-rate home loan, this rate cut will help you repay your loan faster and reduce your total interest cost.

 

While borrowers may expect their equated monthly installments (EMIs) to drop, many banks typically prefer to keep the EMI the same and instead shorten the loan tenure. This strategy allows borrowers to pay off their loans faster, reducing the overall interest they pay.

 

Value Research explains how the repo rate cut impacts loans

For example, consider a Rs 50 lakh home loan with an interest rate of 8.5% over 20 years. The EMI before the rate cut is Rs 43,391. With the rate reduction to 8.25%, the EMI remains the same, but the loan tenure is shortened by 10 months, saving the borrower Rs 3.5 lakh in interest over the life of the loan.

 

Similarly, for a Rs 10 lakh auto loan with an interest rate of 10%, the EMI before the rate cut is Rs 21,247 for five years. After the rate reduction to 9.75%, the EMI stays at Rs 21,247, but the loan tenure is shortened by three months, resulting in a Rs 15,000 savings on interest. 

Those with repo-linked loans Borrowers with repo-linked loans could start seeing the benefits within two to three months. However, it's important to note that banks may not pass on the full benefit of the rate cut immediately. In some cases, banks may delay reducing rates due to liquidity concerns. Despite this, the overall impact will help borrowers save on interest and pay off their loans more quickly.

  What is better for you?  

"While many borrowers may hope for a lower EMI, a reduction in the loan tenure is actually better. By maintaining the same EMI and shortening the loan tenure, you pay off the loan faster and save more on interest. This helps you clear your debt sooner without affecting your monthly cash flow," noted Value Research.  

Adhil Shetty, CEO of Bankbazaar.com explains this better:

Car loans and home loans, both, can be on fixed or floating rates. But most home loans have floating rates, and most car loans have fixed rates. On fixed rate loans, there's going to be no impact of the repo rate cut. On floating rate loans, the borrowers should receive either full or partial transmission of the 25 bps rate cut. This works in one of the following two ways.

 

One: if the loans are repo-linked and taken from a bank after October 2019, the rates will automatically readjust by 25 bps within a quarter. 

 

Two: in all other cases, borrowers may need to speak to their lender or read their loan contract to understand when and by how much their rate will readjust. 

 

"With home loans especially, we see the lowest rates going below 8.30% after this rate cut. So if your current rate is substantially above that mark despite being a borrower with stable income, timely payments, and a credit score over 750, you should seek a refinancing or balance transfer option to reduce your interest burden. 'Substantial' can mean 50 bps or higher. 

 

Do note: this works best when more than half your loan balance or tenor are pending, and you'll recover the refinancing costs (usually 1-2%) of the loan value in a few quarters. We have broken this down in detail in our other story," added Shetty.