Starting April 1 this year, all new floating rate loans moved to MCLR regime. MCLR stands for Marginal Cost of Funds based Lending Rate. Under MCLR regime, the lending rate is linked to borrowing cost (deposit rates) of the banks.
Till March this year, floating rate loans were linked to base rate. Under base rate regime, banks could exercise a lot of discretion in setting lending rate. Not anymore.
All floating rate loans sanctioned after March 31, 2016 will be offered at MCLR + Spread. Existing home loan borrowers (before March 31, 2016) may also be offered an option by respective banks to switch from base rate to MCLR.
In this post, I will discuss a few aspects about MCLR that you must be aware of.
1. MCLR is certainly more transparent than Base Rate.
Under MCLR, the interest (lending) rate is linked to the incremental borrowing cost of the bank.
Hence, the banks may not be able to exercise discretion as in case of base rate.
If a bank can raise funds (accept deposits) at a lower cost, then MCLR will be automatically revised downwards.
For more on how MCLR is calculated, please go through the following post.
Must Read: MCLR Decoded
2. Your loan interest rate will be MCLR + Spread
MCLR is not the only thing you need to focus on. There is an associated spread too. The spread is typically a function of your risk profile i.e. your ability to repay the loan.
3. MCLR is not linked to Repo Rate
MCLR is not linked to Repo rate announced by the Reserve Bank of India. It is linked to the incremental borrowing cost of the bank.
Hence, there is no need to rejoice when RBI cuts repo rates. It may not lead to revision in your home loan interest rate.
Your home loan MCLR is not linked to the repo rate. Of course, you can expect borrowing cost of the banks to come down if the RBI were to cut repo rates. Lower borrowing cost will lead to lower MCLR for your loan.
4. Which loans will be linked to MCLR?
All floating rates loans will be linked to MCLR. Fixed rate loans with tenor of greater than 3 years will not linked to MCLR. Hence, banks retain the pricing power when it comes to fixed rate loans.
Typically personal loans and car loans are fixed rate loans and won’t fall under MCLR regime.
5. MCLR is a double edged sword
Just like MCLR will enable swift transmission of interest rates when the interest rates are going down, it will also lead to quick transmission when the interest rates are rising.
Both rate cuts and rate hikes will be transferred quickly to the borrowers.
Hence, it can be a double edged sword.
However, banks are typically quite swift in passing on the increase in interest rates. I wouldn’t take this aspect negative for MCLR linked loans.
6. You may have to wait before your MCLR is revised
MCLR linked loan also have an interest reset period. The loan agreement will define how frequently your MCLR will be revised. Banks have to compulsorily announce at least 5 MCLRs (overnight, 1-month, 3-month, 6-month, 1-year). Banks have discretion to announce MCLR of higher maturity too.
Different types of loans will be linked to different MCLRs.
For instance, a few banks such as Kotak Mahindra have linked home loans to 6-month MCLR while others such as SBI and ICICI have linked home loans to 1-year MCLR.
Even though MCLR will be reviewed (and revised, if required) every month by the bank, your loan interest rate will be revised only at the next interest reset date (as per your loan agreement).
For instance, if your home loan is linked to 1-year MCLR, the interest reset dates for your loan will be a year apart. For instance, May 1, 2016, May 1, 2017 and so on.
Even if 1-year MCLR gets revised in September, 2016, your home loan interest rate will not be revised till May 1, 2017. You will have to wait.
Had your home loan been linked to Base rate, the home loan interest rate would have been revised as soon as the base rate was changed.
7. Your existing home loans will continue to be linked to Base rate
If you took home loan before March 31, 2016, your home loan would have been linked to base rate.
Your existing base rate linked home loan will not automatically be converted into a MCLR linked loan.
You have to request your bank to convert the loan to MCLR. Your bank may permit it at a cost/fee.
Do note new borrowers do not have option to go for a base rate linked loan.
8. Whether you should switch from Base Rate to MCLR?
Depends on the switching cost. There might be additional administration and documentation charges. You are advised to check all the charges with the bank before deciding to make the switch.
MCLR is clearly more transparent. For me, MCLR is a winner over base rate for the same reason.
However, do remember MCLR can be a double edged sword. Rate hikes will be passed as swiftly as rate cuts. Moreover, consider the impact of interest reset periods before deciding to switch. And yes, you won’t be allowed to switch back to base rate.
For home loan borrowers, switching loan to a different bank is always an option.