Buying home is a lengthy and tiring process especially when you avail home loan to buy it. Tenure of loan is normally in the range of 15 to 20 years and a fair share of anxiety is caused by changing interest rate scenario for floating rate loans during this period. Old customers frown when key policy rates go up and they frown again when it goes down. Read on to understand how housing loan interest rates are linked to key policy decisions like variation in repo rate and CRR together with its impact on old/new home loan borrowers.
How Home Loan Rates are Calculated?
RBI has defined guidelines based on which banks fix their base rate for lending. No bank is allowed to lend below the base rate and base rates differ slightly from bank to bank.
Once a customer approaches a bank for home loan, he is charged a premium over base rate. Premium charged may vary from customer to customer based on his creditworthiness and other factors. Hence, the exact home loan rate a customer will be charged is as follows:
Home Loan rate = Base Rate + Premium
(Premium varies from bank to bank and customer to customer)
Relationship between Policy Rates and Home Loan Rates
Base rate for banks is calculated based on cost of funds for them. Repo Rate and CRR bears direct relationship with the cost of funds. Repo rate is the rate at which RBI lends money to banks and CRR is cash which banks need to keep with RBI as a regulatory requirement. As repo rate increases, cost of funds increase for the banks and this puts upward pressure on base rate. RBI pays no interest on CRR amount hence, when CRR goes up cost of funds increases for the banks. Similarly, situation reverses when there is repo rate and CRR cut.
Correlation between the repo rate and CRR with base rate is direct as they move in the same direction, but the correlation is weak for repo rate and strong for CRR.
Key Observations – How banks behave in case of variation in repo and CRR
It’s easy for banks to lower the base rate in case of CRR cut and pass on the benefit to its customers as compared to repo rate cuts. Same is visible in their action. They respond slowly to repo cuts and hesitate in passing the benefits to customers while CRR cut affects base rate quickly. Banks act more swiftly when policy rates are increased. Increase in repo rate or CRR immediately impacts the base rate resulting in a proportional increase. As a borrower few important points to note here are:
- Banks push base rate up immediately once RBI increases the repo rate and CRR
- Most banks hesitate to reduce the base rate in case of repo rate and CRR cut by RBI
- Private banks in general are more responsive to policy rate variations by RBI
Effect of policy rate cuts – Existing customer vs. new customer
One should not forget that banks are business houses and they will always try to increase their profit margin. This is the reason why they respond slowly while policy rate cuts are announced and swiftly when rates are revised upwards.
Changes in key policy rates affect the existing and new loan customer in the following way:
Existing Home Loan Customers – If you are an existing customer you will always be at the receiving end. Base rate will swiftly increase in case of increase in policy rates resulting in increase in EMI or increase in tenure of your loan. Contrary to this, when policy rates will be cut, bank would hesitate in passing on the benefit to you by reducing the base rate. If the bank is too hesitant in passing the benefit, you can opt for loan transfer and choose a more ethical vendor.
New Home Loan Borrowers – To acquire new borrowers, banks play with the premium they charge over base rate rather than the base rate itself in case of policy rate cuts. They reduce premium to lure new customers and make it sound like passing benefit to the customers. This is the reason new customer gets loan at lower rate compared to the existing one in falling interest rate scenario. If you are planning for a home loan, just wait for the right moment as you can negotiate better rates.
Banks and home finance companies will always try to protect their profit margins, hence you should not expect too much from them. But if you feel that you are getting a raw deal every time, you can look for a loan transfer facility. Talk to an advisor for getting more clarity on the transaction cost involved in the loan transfer process and opt for it if benefits exceed the cost.