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Lending rates fall. What should you do?

While MCLR-based interest rates are now among the lowest in recent years, banks have increased their spreads on the MCLR

The year has started with a bang for new home loan borrowers, with some banks slashing their marginal cost of funds-based lending rate (MCLR) by as much as 90 basis points. This is one of the steepest cuts in recent times. One basis point is one hundredth of a percentage point. MCLR is the new benchmark lending rate linked to all floating rate loans. Currently, most home loans are linked either to 6-month or 1-year MCLRs.

If you are a new borrower, these are among the lowest interest rates in recent years. But there is a catch: banks have increased their spread on home loan rates. Spread is a margin that you have to pay over the MCLR rate. For instance, State Bank of India (SBI), the country’s largest bank, has cut the interest rate on 1-year MCLR by 90 bps to 8%. But it has increased the spread from 20-25 bps to 60-65 bps. So, effectively, the home loan rates have come down by 45-50 bps, from 9.10-9.15% to 8.60-8.65%.

“The spread is determined by a lot of factors. At this point, this (65 bps) is the spread we can afford. We will see how the response is and then take a further call," said Arundhati Bhattacharya, chairperson, SBI.

Banks announce new MCLR rates monthly; some on the first and some on the seventh. So, expect more banks to cut rates this week.

If you plan to take a home loan, see the MCLR and the spread to know the home loan rate. SBI is also offering a 2-year fixed rate home loan at 8.50-8.55%, for amounts up to Rs30 lakh. “Since SBI is offering a lower fixed rate loan, it is an indicator that MCLR is likely to fall further in the next one year. Though fixed rates are lower than floating rates, opt for a floating rate loan as rates may fall further," said Naveen Kukreja, co-founder and chief executive officer, Paisabazaar.com, an online loan portal.

MCLR came into effect in April 2016. If you took a floating home loan after 1 April 2016, you are not likely to see an immediate impact. Most banks have a reset clause of 6 months to 1 year. For instance, if you took a loan linked to 1-year MCLR in August 2016, your loan rate will get reset only in August 2017.

“The MCLR will get reset on the prevailing rate either in 6 months or 1 year, depending on the MCLR you are on. The spread remains constant. We link our home loan to 6-month MCLR. Hence, we have already changed the MCLR rates for those customers who have completed 6 months," said Jagdeep Mallareddy, executive vice-president, retail lending and payments, Axis Bank Ltd.

In a falling interest rate regime, you will benefit once you complete the loan cycle. “Though you may not see an immediate relief, you will benefit from the fall in interest rates eventually," said Rishi Mehra, founder, Deal4loans, a loan comparison portal.

Many of the old home loan borrowers are on base rate. Base rate was the benchmark lending rate before MCLR came into effect. The current base rates are higher than MCLR rates. For instance, ICICI Bank Ltd’s base rate is 9.30% while the 1-year MCLR is 8.90%. If you are on a base rate, this may be the right time to evaluate the balance transfer option.

“In the home loan segment, currently 15% of our home loan consumers are on MCLR. These are both new borrowers and the ones that have switched," said Bhattacharya.

To do a balance transfer, check the transfer cost, outstanding loan amount, tenor and difference in the interest rates. If your outstanding amount is low and only a few years away, a balance transfer may not work because the transfer cost will nullify the benefit. Don’t go for a short-term promotion offers—say, a fixed rate loan for 2 years—when you opt for a balance transfer.

The housing finance companies too are likely to cut rates but not at the speed of banks. “Housing finance companies have to work with a spread, since they have a different cost structure. They don’t have CASA (current account savings account) to rely on. Their own capital will be around 15%, while 85% is borrowed from the system. So, they are market driven and some may reduce rates," said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services LLP. If you are on a loan from a home finance company, you may want to wait for 1-2 weeks to see if interest rates fall. If you decide to switch to a bank, there may be a prepayment penalty.

A back of the envelop calculation shows that if you take a loan of Rs50 lakh at 8.65%, compared with a loan at 9.25% for a 20-year tenure, you will end up saving Rs4,23,462.

“A speedier transmission of rate reduction may perhaps result in profitability of public sector banks under pressure points. If the recovery doesn’t improve dramatically, more capital may be needed," said Parekh.

For consumers, however, the steep cut looks attractive. “MCLR also has the ability to move back to a little higher rate faster than base rate. If you want to switch the loan, wait for the dust to settle and take a decision after a couple of weeks," said Mallareddy.

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