From MCLR to repo-linked loans, pick lenders with low, stable spread

The one-year median marginal cost of funds-based lending rate (MCLR) remained at 9 per cent between November and April, barring a brief rise to 9.05 per cent in February, according to data from the Reserve Bank of India (RBI). This occurred despite a 50 basis points (bps) cut in the repo rate since February this year. Around 36 per cent of floating rate loans are linked to the MCLR.

 

MCLR rate: Responds with lag 

Banks are typically quick to raise rates after repo hikes but slow to reduce them following cuts. “They are quick to respond when the policy rate rises due to the immediate impact on their cost of borrowing, which affects their margins,” says Adhil Shetty, chief executive officer (CEO), Bankbazaar.com.

 

They are slower to reduce rates after a rate cut because MCLR is influenced by more than just the policy rate  —  it also factors in the marginal cost of funds, operating costs, and tenor premium. “Banks cannot easily reprice their existing fixed deposits, as very few are linked to a floating rate. Even when pricing fresh deposits, they must account for liquidity conditions and gaps in their credit and deposit growth,” says Santosh Agarwal, CEO, Paisabazaar.

 

MCLR-linked loans reset every 3 to 12 months. “Borrowers whose home loans are linked to the MCLR would continue to service their loans at existing interest rates till the next reset date,” says Agarwal.

 

A spread is added to the MCLR when determining the loan rate. “Banks have discretion in determining the spread. This makes the MCLR-linked home loan rate less transparent and less responsive to policy rate changes,” says Raoul Kapoor, co-CEO, Andromeda Sales and Distribution.

 

Repo-linked loan: More responsive 

Repo rate-linked loans — also called external benchmark lending rate (EBLR) linked loans — are more responsive to policy changes. “These loans are directly tied to the repo rate set by the RBI during its bimonthly Monetary Policy Committee (MPC) meetings. Changes in interest rates are passed on to borrowers more quickly, typically within two–three months,” says Kapoor.

 

Agarwal points out that rate changes in the external benchmark are transmitted automatically, without being influenced by a bank’s internal cost structure.

 

The spread is less arbitrary. “The spread on such loans is fixed at the time of agreement and cannot be altered arbitrarily,” says Kapoor. Shetty adds that many banks offer competitive spreads, which enhances their appeal.

 

Internal switch option 

Borrowers should consider switching from an MCLR-linked to a repo rate-linked loan. “If other lenders offer lower interest rates on their home loans, borrowers should ask the existing lender to match those rates,” says Agarwal. If the lender agrees, switch internally.

 

No new loan agreement is required; the existing one is amended. “Check the revised terms, especially the spread over the repo rate, loan tenor and EMI,” says Shetty. A nominal conversion fee is charged. If the lender refuses to match the lower rate, explore a balance transfer.

 

Choosing the new lender 

Interest rate should not be the sole consideration for choosing the new lender. “Choose one known for maintaining a low and stable spread. Also opt for one with a quarterly rate reset,” says Shetty.

 

Assess processing fees, legal and valuation charges, service quality, and the lender’s transparency. “Choose a lender with a borrower-friendly structure and responsive service,” says Kapoor.

 

Since most borrowers prepay loans, avoid lenders with restrictive prepayment clauses. Lastly, ensure the savings from switching outweigh the associated costs. 

Steps to Follow When Switching Lenders 

Obtain a foreclosure letter and loan statement from your existing bank

 

Apply for a balance transfer with the new lender 

 

Complete documentation and valuation processes

 

Upon approval, the new lender disburses the amount to close your old loan (entire procedure may take 15-30 days)

 

Source: Bankbazaar.com