MCLR Based Home Loans: Everything One Should Know

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17 MAY, 2021

Home loan interest rates have a significant bearing on your total repayment amount. It can increase or decrease the cost of borrowing and thus, your monthly EMI. This is why it is important to be careful while choosing a home loan and interest rates. If you avail a home loan at a fixed rate of interest, your interest payout remains constant throughout the tenure. However, if you opt for a floating rate home loan, your interest payout can change as per the change in its benchmark rate. MCLR is a benchmark rate that banks use to determine interest rate. So, if there is a reduction in the MCLR rate, you can get the benefit of the cuts in the near future.

Let us know more about MCLR below.

What is MCLR?

MCLR is the abbreviation of Marginal Cost of Funds-based Lending Rate. It refers to the minimum interest rate below which the banks or financial institution cannot lend you money. It is an internal benchmark rate or reference rate based on which the banks determine your interest rate. In simple words, MCLR is the lowest rate at which banks lend you money. Earlier banks used base rate to determine the interest rates. However, it was replaced by MCLR in 2016 by the Reserve Bank of India.

The MCLR is calculated by the banks basis four components – marginal cost of funds, negative carry on account of cash reserve ratio (CRR), tenure premium and operating costs of the bank.

How is it Different from the Base Rate?

The base rate regime used by banks before 2016 was the minimum rate at which the lenders could lend you money. The interest charged by the bank included the base rate plus a minimum spread of 50 basis points. However, in the base rate regime, the borrowers did not get the expected benefit of the fall in broader market rates. In the base rate regime, the change in the RBIs interest rate was not transmitted to the borrowers efficiently. Even if the banks did pass on the rate cuts, a major delay reduced the benefit of the rate cut to the borrowers. To fix this loophole, the base rate system was replaced by MCLR in 2016. The biggest benefit of MCLR based home loans is that the benefit of the rate cut is passed on to the borrowers more efficiently.

How is Your Home Loan Affected by the MCLR?

A change in the MCLR rate brings a corresponding change in your EMI or tenure. A fall in MCLR can reduce your EMI or tenure. However, as there is a reset period in MCLR based home loans, you might not get immediate benefit unless your reset period is round the corner. MCLR based home loans help bring transparency in interest rate determination. It also facilitates better transmission of the benefit of rate cuts to borrowers.

In a nutshell

Compared to the base rate, MCLR is a respite for borrowers with floating interest rates. If you have availed home financing after April 2016, it is likely that your loan is linked to MCLR. However, if you have availed a home loan before April 2016, it would be based on base rate. But, you can switch it to MCLR if you want. Also, we suggest to use a home loan calculator in order to make an informed decision before making that switch by calculating the benefit you stand to gain.

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