How MCLR will affect your Home Loan?

Banks are giving loans based on a new system—Marginal Cost of funds-based Lending Rate (MCLR). The RBI introduced this system from 1st April 2016 in the banks. Till March, the loans were based on the base rate system. The new system will help improve the transfer of benefits to the borrowers. The interest rate for MCLR linked loans is at least 0.10% less than the interest rates for base rate-linked home loans.

So, what is MCLR?

MCLR is the new benchmark lending rate at which the bank will lend to the borrowers.

MCLR has 4 components -the marginal cost of funds, cash reserve ratio (CRR), operating costs and tenure premium.

The marginal cost of funds is the marginal cost of borrowing and return on the net worth for the bank. The operating cost is the cost of providing the loan product with the inclusion of the cost of raising funds. Tenure premium increases from loan commitments with longer tenures. MCLR is more closely linked to the actual deposit rates.

The current one-year term deposit is at 7.25%. So the MCLR will be 7.25% plus CRR, operation cost and tenure premium

According to the Reserve Bank of India (RBI), the banks will have to set at least five MCLR rates—overnight, 1 month, 3 months, 6 months and 1 year. The banks are free to set rates for long durations too as per RBI guidelines. The rates will be reviewed on a monthly basis but if the bank does not have the capacity to do monthly reviews can do quarterly ones. This option is valid until March 2017.

MCLR-linked loans are set for a maximum of one year. The person will be given a new interest rate on the home loan at a predetermined time and for a maximum period of one year.

MCLR affected loans

MCLR is linked to all the floating rate loans. The MCLR linked loans are for home loans and the loan against property.

Home Loan

How does MCLR function?

A new borrower who is looking for a floating rate home loan then it will be linked to MCLR.MCLR linked loans will have a reset clause in the loan documents and the person will have a spread rate.

The spread rate is the margin that a person pays over the MCLR. Let’s say if the MCLR is 9.45% and the spread for a particular bank is 0.55% so the interest rate charged will be 10.00%.

The reset clause will depend on the bank and will vary. Some banks have a 1-year reset clause whereas some banks have a reset clause of 6-months. The reset will depend on the deposit rates at the time of the reset. The interest rate will rise if the deposit rates are high and vice versa.

Effect of MCLR on EMI

Generally, the MCLR will affect the tenure of the home loan and not the EMI of the borrower. When the rate of MCLR is changed, the tenure of the loan will be altered but the EMI will remain unchanged. The EMI is changed in case the tenure crosses a point beyond which the banks don’t lend. A lender can also ask the bank to reset the EMI and not the EMI.

Can an existing borrower change to MCLR?

MCLR linked loans are available at a cheaper rate compared to present loans. The existing home loan borrowers can switch from base rate to MCLR, but one has to pay a price for that.

The customer will have to pay a conversion fee for changing to MCLR based rates. If a current home loan is at 9.20% and the MCLR is at 9.15%. And the person doesn’t want to pay the processing fee for the conversion to shift to MCLR, one can continue to pay the loan at 9.20% for one year, after which the new rates will be effective. Both the above options are available to the borrower. Though one will have to inform the bank to change the rates to MCLR rates, it will not happen automatically.

Compare before switching to MCLR

The banks charge 0.50% of the outstanding principal amount as a conversion rate. Some banks also have a flat fee for conversion. Some additional costs are also applicable.

Before shifting the loan to the new interest rate system one should calculate all the costs and compare both the systems. Though, one should change the loan plan if there is a difference of more than 0.25% of interest rates.

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