Understanding How Repo Rate Impacts Your Home Loan

When you embark on the journey of homeownership, one of the crucial financial considerations is obtaining a home loan. As you explore different loan options, you should clearly understand how banks calculate interest rates. If you’ve ever heard terms like “Inflation is rising,” or “RBI is raising repo rates,” and wondered what is repo rate, here’s what you need to know.

The repo rate is a money tool controlled by the Reserve Bank of India (RBI), and it’s essentially the bank repo rate at which banks need to borrow from the RBI to pay for their loans. Why should you care? In the end, it directly impacts what many of us want to do – buy a home.

In this article, we will explain the repo rate concept and discuss how it influences your mortgage. Also, the bank rate vs. repo rate, what is the current repo rate, and its connection to home loan interest rates. We’ll also examine the home loan repo rate and its effects, providing you with a comprehensive understanding of how this essential financial factor influences your path to homeownership.

Table of Contents

• Repo Rate
• Current Repo Rate
• Repo Rate’s Effect on Home Loans
• Role of the RBI and MCLR

What is the Repo Rate?

The repo rate, short for repurchase rate, is the interest rate at which the RBI lends funds to commercial lenders, such as banks and non-banking finance companies. The Reserve Bank of India (RBI) is the central financial institution that plays a pivotal role in shaping the country’s monetary policy. To achieve its objectives of maintaining price stability and controlling inflation while fostering economic growth, the RBI uses a tool known as the repo rate.

During times of financial strain or economic instability, banks can access additional funds through this mechanism. When the economy faces inflationary pressures or a need for monetary tightening, the RBI increases the repo rate. Conversely, during periods of economic stability or when the RBI seeks to stimulate economic growth, it may decrease the repo rate.

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What is the Current Repo rate?

In 2023, the Reserve Bank of India’s Monetary Policy Committee (MPC) made significant decisions regarding interest rates. On February 8, 2023, the repo rate increased by 0.25 percent to 6.50 percent, while the reverse repo rate remained at 3.35 percent. The bank rate and the marginal standing facility rate were adjusted to 5.15 percent and 6.75 percent, respectively.

During the June 8, 2023 meeting, the MPC chose to maintain the repo rate at 6.50 percent. Five out of six members voted in favor of the policy stance, emphasizing the importance of ‘withdrawal of accommodation’ to control inflation within the desired 4% range while supporting economic growth.

On August 10, 2023, the MPC again kept the repo rate steady at 6.50 percent, concurrently revising the inflation forecast for the July-September quarter to 6.2 percent. The decision had notable implications for the home loan interest rate of all banks which is closely tied to the home loan repo rate.

Repo Rate’s Effect on Home Loans

Now that we understand the role of the repo rate in the broader economic context, let’s explore how it directly influences your home loan:

1. Interest Rate Fluctuations: The repo rate serves as a benchmark for determining interest rates in the economy. When the RBI lowers the repo rate, banks tend to follow suit by reducing home loan interest rates they offer on various loans, including home loans. This reduction in interest rates translates into more affordable home loans for borrowers. However, it’s crucial to note what happens when the repo rate increases because that can have the opposite effect on home loan repo rates and affordability.

2. Affordability and EMIs: A lower repo rate leads to reduced interest rates on home loans, which, in turn, results in lower Equated Monthly Installments (EMIs). With lower EMIs, borrowers can either afford to borrow more money for the same EMI or pay less for the same loan amount. This enhanced affordability can significantly impact your decision-making when purchasing a home. This repo rate change can have a significant impact on your monthly budget. It’s essential to consider how the repo rate increase affects your ability to afford your dream home and the overall cost of borrowing.

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3. Impact on Existing Borrowers: If you are an existing homeowner with a floating rate home loan, your EMIs can fluctuate with changes in the repo rate. An increase in the repo rate may lead to higher EMIs, potentially affecting your monthly budget. Conversely, a repo rate decrease could result in lower EMIs, offering some financial relief to existing borrowers.

An Example of the Impact of Repo Rate on Home Loan EMIs

Suppose you have taken out a home loan of INR 30 Lacs with a tenure of 15 years. If your bank is currently offering an interest rate of 8.75%, your monthly EMI would be approximately ₹29,983. Now, let’s assume the RBI announces a repo rate cut of 25 basis points (bps), leading to a reduction in your bank’s lending rates. If your bank passes on this entire benefit to you as a borrower, your monthly EMI could decrease to ₹29,542.

Although this may appear to be a modest reduction on the surface, for your loan’s tenure, it could result in substantial savings. In this example, you could save approximately ₹80,000 throughout the life of the loan, making it a significant long-term benefit.

Role of the RBI and MCLR

To ensure that borrowers can indeed benefit from home loan repo rate reductions, the RBI introduced the Marginal Cost of Fund Based Lending Rates (MCLR) regime. Under this system, banks are required to charge interest rates based on RBI guidelines, and these rates cannot be lower than the limits set by the RBI. The introduction of MCLR has transformed the way commercial lenders operate.

Under the MCLR system, banks are obligated to inform their customers about the new interest rates each month, with a minimum tenure of five years. This increased transparency ensures that borrowers have better visibility into the interest rate changes and can reap the benefits of repo rate reductions more effectively.

Additionally, the MCLR system enforces a cap on the margin banks can add to the repo rate while lending funds. This regulation aims to establish a stronger relationship between the repo rate and EMIs, as banks cannot impose excessive margins on interest rates.

Conclusion

In conclusion, the repo rate, despite its complexity, plays a critical role in shaping the interest rates offered to borrowers, particularly in the context of home loans. Understanding how changes in the repo rate affect your home loan EMIs empowers you to make informed financial decisions. By staying informed about economic conditions and considering the repo rate’s impact, you can navigate the intricate world of home loans more effectively.

FAQs about the Effect of Repo Rate on Home Loans