All banks have been directed by the Reserve Bank of India to make a shift to the (Marginal Cost of Funds based Lending Rate (MCLR) for all home loans sanctioned on or after 1 April 2016. This is a marked difference from the earlier practice of banks pricing their loans at Base Rate plus a spread. Though the move is intended to pass on the benefit of falling rates to customers, there remains a lot of confusion among people who have taken home loans or intend to apply for one. Some essential aspects clarified:
What Is MCLR?
MCLR is the new benchmark lending rate applicable for banks in place of the earlier base rate. The new system is applicable for all loans given out after 1 April 2016. The old system continues for the loans that were sanctioned earlier but even these applicants are being given the facility to switch over to the new rate regime. Banks are now compelled to announce five MCLR rates that are applicable for different durations such as overnight/1/3/6 and 12 months and they may also choose to have rates for longer periods. All loans that were earlier on a floating rate have to be compulsorily changed over to MCLR – this is not limited to home loans only but also to other loans such as education loans, auto loans, etc. Banks have the liberty of resetting the rate at intervals specified in the agreement with the customer, and the new rate will depend on the deposit rates then applicable plus a spread.
Impact of Changing MCLR on Home Loans
With the reset clause activated by the bank at specified intervals, the applicable housing loan interest rate will rise or fall depending on the prevailing deposit rates. If the rate rises, the EMI will be increased, however, when the rate falls, usually the tenor not the EMI will be reduced. The customer may request the bank to reduce the EMI if that is what he wants, but the maximum tenor permitted by the bank should not be exceeded.
Moving to MCLR
Existing borrowers whose home loans are at base rate plus spread can apply to their banks to make the switch over to MCLR. You need to remember that there is no provision for an automatic changeover. Customers will also be required to pay a fee for the rate conversion else continue with the old rate till it becomes aligned with MCLR in due course. Some banks can ask for a percent of the outstanding principal or even a flat fee for the rate switch together with some administrative costs.
When taking a decision to shift, you should factor in the cost of shifting versus the benefit. If the difference in rates is relatively small and the balance of the loan tenor short, then it may be wise not to make the changeover and stick with the benchmark prime lending rate. However, it may be possible to negotiate with the bank for the switching and administrative fees, especially if you have a good credit score, and your loan amount is high. Even though there is nothing the bank can do about the MCLR itself, it can certainly sweeten the deal by reducing processing costs.
Since you cannot move back to the earlier system once you have shifted your loan to MCLR, you should evaluate thoroughly if you should at all take the trouble and expense. According to experts, the long-term projection of interest rates is that they will continue to dip and customers should take the advantage of the new interest regime if they have a fairly long loan tenor left that will make it worthwhile even after paying the conversion charges.