Simply put: how is the interest rate on your home loan determined?


Rishi and Kabir ran into each other at their favorite fast food joint and their conversation went like this:

Rishi: This interest rate story is strange. The RBI has raised the repo rate, but HR Bank’s interest rate is lower than mine at SS Bank.

Kabir: Your bank’s MCLR may be higher than HR Bank’s.

Rishi: What is that?

Kabir: MCLR (Marginal Cost of Funds Based Lending Rate) is the rate threshold below which banks cannot lend. This rate is obtained according to a formula specified by the RBI and is different for each bank depending on the variables. MCLR is calculated as the marginal cost of funds (repo rate) + operating costs + CRR + duration premium (a premium charged by banks for higher durations). Once the MCLR is determined, a spread is added to arrive at the final interest rate. So HR Bank might be able to offer a lower interest rate than your SS Bank because it might have a lower MCLR.

Rishi: Interesting. But has this always been the case?

Kabir: The MCLR was introduced in 2016. Previously, loans were made with the base rate as a reference. The the base rate is calculated by adding the average cost of funds or the interest rate on deposits and the cost of maintaining the CRR, together with the profit margin. This differs from the MCLR in that instead of the repo rate, it is based on the average cost of its deposits.

Rishi: Okay, but why was MCLR introduced when the base rate seems fair enough?

Kabir: The base rate takes the average cost of deposits on the date and therefore consumers cannot benefit from changes in the repo rate while the MCLR changes according to the repo rate.

Rishi: I also heard of something called BPLR. What is that?

Kabir: The Prime Reference Rate (BPLR) was the rate introduced by the RBI in 2003. It was the rate at which banks lent to their most creditworthy customers. However, this system was less transparent and the banks even lent at rates lower than the BPLR to certain privileged customers. This is the reason why the BPLR has been replaced by the base rate.

Rishi: What types of rates are currently prevailing, and which is the best?

Kabir: Of As of April 1, 2016, all loans are, by default, based on MCLR, but loans taken out before this period will be referenced to the base rate with an option to switch to MCLR. Under the base rate, the change in the pension rate is not reflected immediately, whereas in the MCLR, the change is reflected immediately because these rates have to be decided monthly. If a borrower thinks that in the coming periods the repo rate will drop, he can consider switching to MCLR mode and if the loan is about to close soon, he can stick to the rate system basic.


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