All banks moved to a new lending rate regime—the marginal cost of funds-based lending rate (MCLR). Till March-end, new floating rate loans were linked to base rate. The new rate regime is likely to improve transmission of rates to the end consumers. If you check the current interest rates, MCLR-linked home loans are at least 10 basis points (bps) cheaper than base rate-linked home loans. One basis point is one-hundredth of a percentage point.
What does this mean for your existing home loans? What happens to your other loans such as personal loan, auto loan and education loan?
What is MCLR? It is the new benchmark lending rate at which banks will now lend to new borrowers. Till 31 March 2016, banks used base rate as the benchmark rate to lend. While MCLR will be the benchmark rate for new borrowers, for existing borrowers, the base rate regime will continue. MCLR is closely linked to the actual deposit rates. Banks have to publish at least five MCLR rates (overnight, one-month, three-month, six-month and one-year). Banks are also free to set rates for longer durations, such as two and three years (read more on: http://bit.ly/1SKKjem).
Which loans will get linked to MCLR? All floating rate loans will be linked to MCLR. “This includes home loans, loan against property and many of the corporate term loans. Those such as car and personal loans, which are fixed rate loans, will not be linked to MCLR,” said K.V.S. Manian, president–corporate, institutional and investment banking, Kotak Mahindra Bank Ltd.
The country’s largest lender, State Bank of India, has linked its personal, education and auto loans to its MCLR rate.
How does such a loan function? If you are a new borrower who has taken a floating rate home loan, then it will be linked to MCLR. This means two things: one, you will have a reset clause in the loan documents, and two, you will have a spread.
The reset clause will depend on the bank and will vary. For instance, SBI has a one-year reset clause, whereas Kotak Mahindra Bank has a six-month reset clause. So, if you take a home loan from SBI, the interest rate will get reset every year.
The reset will not be arbitrary, but will depend on the deposit rates at that time. If deposit rates are higher, your rate will rise. If they are lower, your home loan rate will fall. If you take a home loan from Kotak Mahindra Bank, your loan will be reset every six months.
All MCLR-linked loans come with a spread, which is the margin that you have to pay over the MCLR. For instance, ICICI Bank Ltd offers one-year MCLR at 9.20%. For a home loan, the spread is 25 bps, which means you get the loan at 9.45%.
Will it change the EMI? Usually, the tenor of the home loan will change and not the equated monthly instalment (EMI). “When MCLR is reset, the tenure of the loan is altered keeping the EMI amount unchanged. But when the tenure crosses a certain number of years, say, 20 or 25 years, beyond which a bank has a policy of not lending, the EMI may change,” said Manian. But if you want to change the EMI and not the tenor, you can inform you bank.
How can an existing borrower move to MCLR? Currently, these loans are cheaper than base rate-linked loans. All existing home loan borrowers can switch from base rate to MCLR, but this comes at a cost.
“The customer will have to either pay a conversion fee or continue at the existing rate. Say, your current home loan is at 9.60%, and at MCLR you will get the loan at 9.45%. If you don’t pay a fee and yet want to shift to MCLR, you will have to continue paying your loan at 9.60% for one year, after which the new rates will be effective. If you pay a conversion cost of, say, 50 bps of outstanding principal, your loan will get reset to 9.45%,” said an SBI official who didn’t want to be named.
Remember that base rate loans will not automatically get converted to MCLR; you have to ask for it.
Should you switch from base rate? Most banks charge 0.50% of the outstanding principal as switching charges. Some may ask for a flat fee. There will be other administrative costs as well.
“Shifting your loan to the new interest rate regime is a function of factoring the lower interest rate and the costs. If you are at a BPLR (benchmark prime lending rate) regime, you will also have to factor in foreclosure charges. If there is a difference of, say, 25 bps and more in the interest rate, and your home loan is of a long tenor, then you should shift the loan. Don’t shift for just a 10-bps benefit,” said Adhil Shetty, chief executive officer and co-founder, BankBazaar.com.
What to check for before opting for an MCLR-linked loan?Besides the rate, you need to check the spread for your loans. “In concept, MCLR is not very different from prime lending rate or base rate. The difference lies in the methodology of how to determine the rate. The method of linkage is the same. There is a spread over MCLR that banks charge. It is important for customers to understand this spread,” said Manian.
Also keep a tab of the administrative process. “Besides the cost, it is important to check whether the process of switching is smooth,” said Naveen Kukreja, managing director, Paisabazaar.com, a loan portal.
Can one negotiate with the bank on any of the charges?You can negotiate the switching charges and other administrative costs. “Though the bank has a list of charges, most of these can be negotiated. If you have a good credit score, you can use it to bring down your costs such as the conversion and processing fees. Banks can’t lend below MCLR, but you can negotiate the spread on it,” said Kukreja.
What happens to other MCLR-linked loans? Some banks have linked their auto, personal and education loans to MCLR. For instance, SBI’s car loan scheme for women is priced at 9.75% (one-year MCLR of 9.20% plus 0.55% spread).
Personal loans have been linked to the two-year MCLR rate and its spread. For instance, SBI’s personal loan interest rate is 11.20-17.70% with a spread of 190-840 bps over two-year MCLR rates.
Loans that are linked to two-year MCLR will get reset after two years. So in a way it is fixed only for two years, post which your interest rate will change.
Which loans are not linked? All fixed rate loans such as fixed rate home loans, auto loans, personal loans are not linked to MCLR. Also, if you have taken a floating rate loan from a non-banking finance company (NBFC), your loan will be linked to the retail prime lending rate and not MCLR. For instance, HDFC Ltd offers home loans at 9.40-9.95% (retail prime lending rate of 16.30% minus spread of 6.35-6.90%).
Also, banks have older floating rate home loans based on BPLR, which was the lending rate used prior to base rate. Such loans will not be linked to MCLR.
If you are an existing home loan borrower and if the switch from base rate to MCLR is only marginal, it doesn’t make sense to make the effort of doing the additional paper work that would be required.
If you are a new borrower, shop around to see which lender is offering the best interest rates after factoring in all costs such as processing fee and administrative costs, and then make a choice.