Different loan benchmarks present a tough choice for home buyers

Banks have 6-month and one-year MCLR; one should choose based on interest rate outlook

In addition to interest rate and processing charges, home loan borrowers should now also look at the Marginal Cost of Funds-based Lending Rate (MCLR), to which the loan is linked because this will tell you frequently your interest rate will change. The shorter the MCLR, the more frequently your loan rate will change. 

For a year now, loans have been linked to the MCLR instead of the base rate. The key difference in calculations is that MCLR factors in the “marginal cost of funds,” which takes into account the cost of borrowings depending on the repo rate; the interest rates offered on deposits; and return on net worth. Unlike MCLR, the base rate only takes into account the cost of funds, which is essentially the interest rates offered on deposits. Due to this, the MCLR is a great deal more responsive to changes to the repo rate. 

“MCLR comes with a reset period for the interest rate. Regardless of the interest fluctuations, the interest would be reset only at the end of the reset period. Different banks offer different reset periods. There is also a tenor premium to offset the risk associated with lending for a longer time, and the rate of interest varies according to the tenor,” says Navin Chandani, chief business development officer, BankBazaar.com.

In a 12-month reset period home loan, let us assume a borrower takes a home loan at 8.5 per cent in June 2017 and the RBI cuts the repo rate in August 2017. Subsequently, the bank cuts its MCLR to 8.35 per cent in the same month. But for the borrower, the effect will be seen only in June 2018, that is, after 12 months. So, the borrower would continue to make payments at 8.50 per cent till the end of 12 months, after which the then prevailing rate of interest will apply. Though the MCLR is reviewed monthly, your home loan will be reset automatically only at the end of your reset period, depending on the agreement with the bank. 

State Bank of India, Bank of Baroda and Punjab National Bank offer home loans linked to one-year MCLR, while Axis Bank has linked it to six-month MCLR. ICICI Bank offers a choice between six-month or one-year MCLR. 

A customer on a six-month MCLR can choose to change the MCLR to 12 months, or vice versa, in the middle of the tenure by paying a service/conversion charge decided by the bank (varies from bank to bank). For instance, ICICI Bank allows this. However, the MCLR tenure can be changed to 12 months at the end of six months at no additional charge if the bank provides such an option.

“If you have the option to select a reset period, base your choice on whether interest rates are rising or falling. If interest rates are falling, opt for a shorter reset period so that you can avail reduced rates sooner. If interest rates are rising, opt for a longer reset period so that your loan burden does not go up for a longer period,” says Chandani.

It also depends on how comfortable the borrower is in terms of the reset frequency says Gaurav Gupta, CEO, Myloancare.in. “If a loan is linked to a one-year MCLR, then interest rate would happen at one-year intervals. If a customer is comfortable with the interest rate he has locked into over the next one-year period, irrespective of whether interest moves up or down, then a one-year MCLR works well. But if the customer wants an immediate movement in interest rate, based on the market rate movement, then one should ideally lock into shorter-tenure MCLR, provided choice is available,” he says.

Many low to medium segment customers may not be comfortable with volatility. For them a longer tenure is better. But someone who can afford the volatility can opt for a shorter tenure, Gupta adds.