Does MCLR Make Home Loans Cheap?

It’s very important to have your own home. It gives a double benefit. A roof over your head and the value of the house appreciates with time. Many young people avail a home loan to buy their dream home. Home loan interest rates are falling in recent times and this might be the right time to buy that dream home.

So why have home loan interest rates fallen? One of the reasons is demonetization. After demonetization, banks were flush with cash as citizens deposited old 500 and 1,000 rupee notes. Banks cut down interest offered on SB accounts and FDs. Most banks offer interest of 3.5% on SB accounts. FD Rates are around 6.5-7% a year.

Another important reason for home loan interest rates falling is the MCLR? What is MCLR? Let’s find out. Want to know more on home loans? We at IndianMoney.com will make it easy for you. Just give us a missed call on 022 6181 6111 to explore our unique Free Advisory Service. IndianMoney.com is not a seller of any financial products. We only provide FREE financial advice/education to ensure that you are not misguided while buying any kind of financial products.

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Does MCLR Make Home Loans Cheap?

Before I tell you what’s MCLR or Marginal Cost-based lending rate, let’s first understand what base rate is. Base rate is the lowest rate banks charge customers who avail loans. No bank could offer an interest rate lower than base rate.

After April 1^st 2016, banks shifted from base rate to MCLR. MCLR is lower than base rate and this means cheap home loans. MCLR is associated with floating rate loans. In floating rate loans, interest rates change with market conditions.

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1. How is MCLR Calculated?

To calculate MCLR you need to understand marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio (CRR).

• Marginal cost of funds: Banks borrow to meet the expenses of their business. Banks then pay interest on the borrowed money. This is called cost of funds.  The additional cost banks incur to fund the purchase of an asset/investment is the marginal cost of funds.

Find this difficult to understand? I’ll explain. Your bank wants to make an investment and the cost of investment is Rs 2,000. Due to some reason, the banks expenses on this investment have increased to Rs 3000. The additional cost (Rs 1,000) is the marginal cost of funds.

• Tenor Premium: Loans have a time of repayment called tenor. Different loans have different tenors or time periods, usually up to a year. If your bank is giving you a loan for a higher tenor (which may be close to a year), there’s a lot of uncertainty and risk involved. Banks are allowed to charge a tenor premium to make up for the risk

• Operating expenses: Banks incur expenses to offer you a loan product.

• Cost of maintaining the cash reserve ratio: Banks have to maintain a certain percentage of their total deposits with RBI in current accounts. This is CRR or cash reserve ratio. The cost of maintaining CRR by banks is charged.

MCLR is quite close to the interest, banks pay on FD deposits. This makes MCLR much lower than base rates.

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2. Why home loan rates are cheap with MCLR?

On a floating rate home loan, banks have a 6-month or a 1-year MCLR as a benchmark. If you choose the 1-year MCLR, banks will reset home loan rates, every one year. Let’s say you have taken Rs 50 Lakh home loan from a bank at 6-month MCLR of 9.5%, on April 1^st 2017. This loan has a spread of 0.5%.

Your home loan will be 10% (9.5% + 0.5%). You have to pay your home loan installments at this rate for 6 months. On October 1^st 2017, your bank revised the 6-month MCLR to 9.3%. The spread remains constant at 0.5%. The home loan interest gets automatically reset to the revised interest rate of 9.8%.

MCLR is a very good option if interest rates are going down. Be Wise, Get Rich.