What is MCLR and How Does It Affect Home Loan EMIs

Important points in this blog:

• MCLR is known as Marginal Cost of Funds-Based Lending rate. It was replaced by an older rate system called BPLR (Benchmark Prime Lending Rate).

• MCLR introduced by RBI (Reserve Bank of India) on April 1, 2016

• MCLR is a benchmark interest rate that banks in India use to determine the interest rates on various types of loans, including home loans.

• Before MCLR there are no centralized system for interest rate such as banks use different methods to find out the interest rate for example: average cost, marginal cost and other this is totally inconsistent and confusing. Here RBI introduced MCLR to make sure RBI changes in interest rate affect quickly, more transparently, and support economic growth.

• When MCLR rates change then the people EMI will affect. Suppose it goes down then the EMI will be down if up then EMI will up.

• Banks must follow MCLR interest rate if they don’t there will be penalty and other actions by RBI.

• Anyone has the option to transition to MCLR from BPLR if they find any advantage.

What is MCLR? And Why was it introduced?

MCLR, short for Marginal Cost of Funds Based Lending Rate, serves as a benchmark interest rate used by banks in India to set rates for loans, including home loans. It replaced the Base Rate system, known for its lack of transparency and slow response to RBI policy rate changes.

The RBI introduced MCLR to improve upon the limitations of the Base Rate system and to enhance the transmission of monetary policy adjustments to borrowers. MCLR aims to offer a more responsive framework that reflects changes in banks' funding costs, promoting transparency and equity in the determination of loan interest rates.

How is MCLR Calculated?

MCLR is calculated based on the following four components:

1. Marginal Cost of Funds: This covers the bank's cost of borrowing money, which depends on the interest rates they pay for deposits and other sources of funds. It also considers the profit they make on their investments.

2. Operating Costs: These are the costs of running and managing the bank's lending activities, like paying for administrative tasks.

3. Tenor Premium: This is an extra cost added to the MCLR depending on how long you'll have the loan. Longer loans usually have a higher premium because there's more risk over time.

4. Negative Carry on Cash Reserve Ratio (CRR): Banks have to keep some of their deposits with the RBI as CRR. This cost is for holding onto these deposits, which don't earn any money for the bank.

The formula for calculating MCLR can be summarized as:

MCLR= Marginal Cost of Funds + Operating Cost + Tenor Premium + Negative Carry on CRR

What is the Impact of MCLR on Home Loan EMIs?

1.Interest Rate Determination

The interest rate on a home loan connected to MCLR is set by adding an extra amount, called a spread or margin, to the MCLR. The bank decides this spread, and it stays the same for the entire loan period unless the borrower's risk level changes.

Let's say the bank's MCLR is 8% and you're applying for a home loan. The bank decides to add a spread or margin of 0.5% to this rate because of your good credit history and stable income. So, your total interest rate on the loan would be 8% (MCLR) + 0.5% (spread) = 8.5%. This 8.5% interest rate would stay the same throughout your loan, unless your financial situation changes significantly.

2.Frequency of MCLR Reset

One of the key features of MCLR is the reset period, which determines how frequently the interest rate on the loan will be reviewed and adjusted. Common reset periods are one year, six months, or three months. The choice of reset period affects how quickly changes in the MCLR will impact your home loan EMIs.

• Annual Reset: The interest rate is checked and changed every year. So, even if the MCLR changes during the year, your loan's interest rate will only be adjusted at the end of each year.

• Semi-Annual or Quarterly Reset: The interest rate is checked every six months or three months. This helps to quickly pass on any changes in the MCLR to your loan interest rate

3.Impact on EMIs

Changes in MCLR can affect your home loan EMIs a lot, especially when interest rates are unstable. If MCLR goes down, your home loan interest rate also drops (assuming the spread stays constant), which means lower EMIs. But if MCLR goes up, your loan interest rate goes higher, so your EMIs will also increase.

Example:

Assume you have a home loan of ₹50 lakhs with an interest rate of 8.5% (MCLR + spread). If the MCLR decreases by 0.25%, the new interest rate will be 8.25%, leading to lower EMIs. Conversely, if the MCLR increases by 0.25%, the new interest rate will be 8.75%, resulting in higher EMIs.

Did you know? Under MCLR, it’s mandatory for banks to declare the interest rate every month whether it's overnight, 1 month, 3 month, 6 month, 1 year, 2 year. Now you can check the MCLR rates of banks on their website.

What are the Factors Affecting MCLR?

1.RBI Policy Rates

The Reserve Bank of India’s policy rates, such as the Repo Rate and Reverse Repo Rate, directly influence the MCLR. When the RBI cuts the Repo Rate, When banks borrow at lower costs, it reduces their expenses and lowers the MCLR. On the other hand, when the RBI raises the Repo Rate, it increases banks' borrowing costs, leading to a higher MCLR.

2.Bank’s Cost of Funds

The cost of funds for a bank, which includes the interest rates paid on deposits and other borrowings, is a critical component in calculating MCLR. Changes in deposit rates or the availability of low-cost funds can impact the MCLR.

3.Operating Costs

The costs of running the bank's lending operations also impact the MCLR. If operating costs are high, the MCLR tends to be higher. Conversely, lower operating costs can lead to a lower MCLR.

4.Market Conditions

Overall market conditions, like how much money is available and how much people want to borrow, affect the MCLR. If there's lots of money available and not many people want loans, banks might lower the MCLR to get more borrowers. But if there's not much money around and lots of people want loans, the MCLR might go up.

You need to understand that: If you have taken a loan before April 1, 2016 then the loan will be automatically linked to MCLR. You can always switch to MCLR if you have taken a loan before April 1, 2016.

Summary

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Conclusion

It's important to understand MCLR and how it affects your home loan EMIs to make smart borrowing choices. Knowing what influences MCLR and planning for interest rate changes can help you get better loan terms and lower EMIs. Whether you're getting a new home loan or already have one tied to MCLR, being proactive and knowing market conditions can help you manage loan interest rates wisely.

How can EazyBankLoan help you in taking a loan? We understand the process of procuring a loan can be stressful. That is why we take care of your Loan application process, saving you time and hassle by handling the paperwork and communication with the loan providers.

Check the details here at EazyBankLoan

Need help? Reach out at support@eazybankloan.com

Frequently Asked Questions (FAQs)

1. What is MCLR?

• MCLR stands for Marginal Cost of Funds Based Lending Rate, a benchmark interest rate used by banks to set loan interest rates.

2. How is MCLR calculated?

• MCLR is calculated based on the marginal cost of funds, operating costs, tenor premium, and negative carry on CRR.

3. How does MCLR affect home loan EMIs?

• Changes in MCLR directly impact the interest rate on home loans, thereby affecting the EMI amount. A lower MCLR reduces EMIs, while a higher MCLR increases them.

4. What is the reset period in MCLR?

• The reset period is the frequency at which the interest rate on a loan linked to MCLR is reviewed and adjusted. Common reset periods are annual, semi-annual, or quarterly.