The interest rate at which the Reserve Bank of India (RBI) lends money to commercial banks is called the repo rate in India. People who wish to avail a home loan need to be aware of the changes in the repo rate. This is because any change in the repo rate will lead to a change in the interest rate of home loans.
While people are aware of the effect of the tenure, interest rate, down payment and Equated Monthly Instalments (EMIs) on a loan, not everyone knows the effect of RBI’s repo rate.
How does a change in repo rate impact home loans?
The points below will illustrate how a change in the repo rate in India affects home loans:
- When RBI lowers the repo rate, the cost of borrowing goes down for banks, as mentioned above. Financial institutions pass this benefit to borrowers who can avail a home loan at a lower cost.
- But when RBI increases the repo rate, the cost of borrowing increases for banks which subsequently increases home loan interest rates.
- An important factor that borrowers must take into account is that banks are quick to increase their interest rates when the repo rates increase. But when there is a decrease in repo rate, banks don’t reduce their lending rates as quickly.
In other words, any change in the repo rate may not have an immediate effect on the interest rates offered by banks and NBFCs. Often, RBI has to nudge these financial institutions to reduce their lending rates when there is a decrease in repo rates.
- If a person has already availed a home loan, then a fall in repo rates can reduce their EMIs substantially. However, this is applicable only if he/she has availed loans with floating interest rates.
- A fall in the repo rate will lead to cheaper interest rates for new home loans.
Previously, banks used MCLR (Marginal Cost of Funds Based Lending Rate), prime lending rate and base rate to determine the interest rates of home loans. These internal benchmarks enabled banks to determine and reset the loan rates at an interval specified in loan agreements.
When it came to MCLR-based home loans, banks had to take into account operating costs, the cost of deposit along with the repo rate. Needless to say, there were much slower transmissions of policy changes.
To help borrowers benefit from RBI’s policy changes, the central bank directed banks to use an external lending benchmark. As a result, banks switched to the repo rate-linked regime in October 2019.
Important factors about repo-rate linked home loans
Borrowers who have availed a repo-rate linked home loan or are considering switching to one must be aware of the following factors:
- Changes in the repo rate will be reflected in one’s outgo quicker than before.
- During a rising interest regime, repo rate-linked home loans may not be conducive for borrowers.
- People should keep in mind that ultimately it is the bank which decides the interest rate. For example, even though the current repo rate stands at 6.50%, the lowest interest rate for a home loan stands at 8.50%.
Repo rate increase effects on consumers
Researchers and analysts cannot pinpoint a standard effect of changes in the repo rate on real estate investors. This is because the factors determining the impact of interest rate increase differ for different categories of investors.
The following points touch upon the effect of an increase in repo rate on homeowners:
- People who have availed a small-ticket loan are not much impacted by repo rate increases.
- But, home buyers who have availed a large loan amount and have chosen floating interest rates for their loans need to be a bit careful. Floating interest rates are linked to an external benchmark such as the repo rate. Any change will be reflected in one’s home loan interest rate within a quarter of the introduction of any changes.
- Considering that real estate investors avail a larger loan amount, they are more affected by rate hikes. Moreover, when lenders increase the interest rates after RBI raises the repo rate, such consumers are required to pay a larger EMI.
What is the reverse repo rate?
The reverse repo rate is the rate of interest on deposits that commercial banks in India keep with the central bank. RBI uses reverse repo rate as a monetary tool to maintain inflation levels and absorb liquidity from India’s economy.
To encourage banks to lend less money to consumers, the central bank may increase the reverse repo rate. It leads to the depletion of excess liquidity from the markets. This prevents banks from having a lot of credit to lend.
What is the current repo rate and reverse repo rate?
Current rates are given below:
- The repo rate as on April 2023 stands at 6.50%.
- The reverse repo rate is 3.35%.
The repo rate is always higher than the reverse repo rate because RBI cannot provide a high interest rate on deposits and levy low interest on loans. It revises these rates on a bi-monthly basis during the central bank’s monetary policy review meetings.
Important tips before taking a home loan
People who wish to avail a home loan to purchase their dream house can read these tips:
There’s not much impact on fixed-interest rate home loan
Potential borrowers must remember that they will not be impacted if they avail a home loan with a fixed interest rate. This is because these interest rates are not subject to any change and will remain the same for a loan’s entire repayment period.
Borrowers should check their credit reports
Lenders will check the credit report of applicants before approving loans because it reflects their creditworthiness. So, applicants must maintain a good credit score. They should pay off their outstanding debts and utility bills on time. It’s important to maintain a good credit score, especially during the loan processing time.
Borrowers can consider using a home loan EMI calculator
Using a home loan EMI calculator will let potential borrowers view their monthly repayment obligations in an instant. Apart from helping with proper financial management, it eliminates any chance of errors.
Many financial institutions offer pre-approved offers for their loyal customers. People need to visit the official websites and enter their name and contact information to check these offers which quickens the application process.
A home loan enables people to fulfil their dreams. But borrowers must remember to check the repo rate in India before applying for one because it has a direct impact on the interest rates offered by lenders.