How To Make The Most Of The MCLR Regime

In case you got your home loan sanctioned after March 31, 2016, on a floating rate of interest, it must be linked to the marginal cost of funds-based lending (MCLR) regime. Loans sanctioned before that period were linked to the base rate regime. However, borrowers have the option to switch to the lending benchmark as it is arguably more beneficial for them.

The word “marginal” has a lot to do with that.

Let us simplify this for you. The base regime took into account the cost of funds — this means the cost of borrowing would primarily depend on the interest rates offered on deposits. Under the new regime, on the other hand, the marginal cost of borrowing is depended on several others factors, including the repo rate and return on net worth, along with the interest rates offered on deposits. In the base rate regime, your bank may not have been quick enough to pass on the benefits of a cut in repo rate to you. In the MCLR regime, they would necessarily have to do it. In short, the MCLR regime is more responsive to change in repo rate — the rate at which the Reserve Bank of India (RBI) lends money to authorised banks.

However, if you expect immediate changes, you may be disappointed as there lies another catch in the form of the reset period. While providing home loans, banks set a reset period of one year or six months (In most cases, they go with the one-year reset clause.) The changes in repo rate will be incorporated in your books depending on this reset period.

Suppose, you took a home loan at 8.60 per cent in April 2017 with a reset period of one year. In the meantime, the RBI reduced repo rate to 8.30 per cent. Now it would only be in April 2018 that your bank will be resetting the terms for you, bringing down the interest rate.  

This may lead you to believe that keeping the reset period shorter may be a better idea. That, however, depends. While the common practice is to offer loans at one-year and six-month reset period, banks have been mandated to publish the internal benchmark for overnight, one-month and three-month under the MCLR regime.

To start with, you must keep in mind that changing circumstances could also prompt the Central bank to increase repo rate at some point in time. In that case, the interest you pay will also increase. If you fail to reap the benefits of a rate cut for a year in case the reset period is for that long, you also escape from paying an additional amount in case there has been a hike in rate.

Second, unless you have the time, the energy and the skills required to watch market movements and plan your strategy accordingly and swiftly, it would be better to go for a longer reset period. On an avid market, water would know that he has to switch to a shorter reset period when the interest rates are falling, and switch back to a longer reset period if the interest rates are rising. For a common man, this may seem complicated.