Is it a wise idea to opt for repo-linked loan?

Moving away from a system of home loans linked to marginal cost of lending rate (MCLR), several banks launched repo-linked lending rate (RLLR) products after the monetary policy committee cut repo rates by 35 basis points in August. In the past, there has been a lot of talk of banks not being able to effectively transmit repo rate cuts to their customers.

State Bank of India (SBI) launched RLLR-based home loan on 1 July. This home loan will be explicitly linked to the RBI’s repo rate and one can directly benefit from a rate cut. SBI has also linked the interest rate on savings bank balances above ₹1 lakh to the repo rate.

Bank of Baroda (BoB), too, announced a new home loan product linked to RLLR on 11 August, as did Oriental Bank of Commerce. Other banks are also likely to follow suit soon. For the time being, the new products are largely restricted to home and auto loans. If you have been wondering why you have not benefited from rate cuts as a borrower, read on to find out why these new products may just be the answer.

Necessary shift

The repo (or repurchase) rate is the rate at which the Reserve Bank of India (RBI) lends money to other banks. Ideally, all interest rates including home loan rates are supposed to be linked to this rate. Hence, cuts in the repo rate are meant to lead to cuts in home loan and other lending rates as banks get to borrow money cheaply from the RBI. However, under the MCLR system, these cuts linked to repo rate (called transmission) were not happening despite RBI rate cuts of 1.1% cumulatively in calendar year 2019.

RBI’s statement in June noted that a 0.5% cumulative cut in February and April resulted in only 0.21% average reduction in fresh rupee loans. On past loans, the weighted average lending rate actually went up by 4 basis points or 0.04%.

Even if banks were to cut rates, for MCLR-linked loans, there is a reset clause, which means that there can be a lag in your home loan rate being changed even if the MCLR changes. But, in the case of RLLR, this won’t happen and the change will happen from the first day of the following month. The RBI is also reportedly mulling making such a linkage compulsory for all banks.

According to Adhil Shetty, chief executive officer, BankBazaar, the RLLR has been on the cards for some time. “With the repo-linked rate, there will be greater transparency about how the rates are fixed and the transmission of the change in repo rates will be more prompt, enabling greater benefits for customers,” he said.

What it means for you

Note that the SBI RLLR includes a “spread” or margin above the RBI rate. This is 2.25% at present. In addition, the bank will charge another 0.40% or 0.55% depending on the borrower’s creditworthiness. This means that the current repo rate of 5.40% translates to 8.05% or 8.20% as your home loan rate. For loans above ₹75 lakh, the spread for creditworthiness ranges from 0.95% to 1.10% (see graphic).

“Fresh borrowers should absolutely go for these repo rate-linked loans since the rate transmission is so transparent,” said Gaurav Gupta, chief executive officer, Myloancare, an online lending platform. However, for existing borrowers he struck a more cautious note. “The rate cut should be at least 0.5% lower than the existing loan cost for a switch to be worthwhile as customers face costs like processing fee and stamp duty while switching,” he said. Your existing bank may soon launch such a product allowing you a cheaper and more hassle-free switch into it.