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[Explained] Banks increase the MCLR. Here’s what it means for borrowers

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Many leading banks have recently raised the marginal cost of funds-based lending rates (MCLR). MCLR-linked loans would therefore become more expensive. Their NDEs and interest expenses will increase.

National Bank of India (SBI), India’s largest public sector bank, also raised the MLCR earlier this week. This decision should be followed by other banks. Bank of Baroda and Axis Bank have already increased their MCLR by five basis points across all mandates. The rises of these banks indicate that interest rates have bottomed out.

If you have an MLCR-linked loan, here are five crucial things you need to know.

MCLR decoding

MCLR, or marginal cost of funds-based lending rate, in simple terms, is the benchmark lending rate at which banks lend to borrowers for different types of loans. The reference rate is the lowest rate at which a bank can lend. MCLR durations range from one night to three years. Banks calculate their MCLRs taking into account the cost of funds collected from the central bank or depositors. The costs are influenced by the duration premium, the operating expenses and the cost of maintaining the cash reserve ratio are taken into account. The RBI introduced the MCLR scheme in April 2016.
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MCLR and loan rates

The retail rate – the rate at which you borrow – is the lender’s benchmark rate plus a markup. For example, suppose a bank has a one-year MCLR of 7.10, on which it applies a mark-up of 40 basis points, giving us a retail rate of 7.50. The mark-up is decided based on factors such as the borrower’s income, credit rating, and the amount they are borrowing. Banks typically compare their home loan rates to their one-year MCLR. MCLRs are subject to revision. In a rising interest rate scenario like today, the cost of funds goes up. This increases the MCLR, which increases loan rates, making them more expensive.

Difference Between MCLR and Pension rate Linked loan

The MCLR is an internal benchmark produced by the bank. Bank loans issued since April 1, 2016 are indexed to the MCLR. This started to change from October 2019 when the Reserve Bank of India ordered banks to compare their retail lending rates against external benchmarks such as the repo rate. Most banks have tied their home loans to the repo rate. The RBI believes that a repo-linked loan is more transparently priced and the pass-through of rate cuts from the regulator to the borrower is better than MCLR-linked loans. The RBI has not changed repo rates for over two years and has kept them at 4%. This has lowered lending rates for loans linked to repo rates. As a result, repo-linked loans are now cheaper than MCLR-linked loans.

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Switching from an MCLR loan to a repo loan

Despite the arrival of repo loans, most loans today are still tied to older benchmarks such as the MCLR. These loans are likely to be more expensive than repo loans. You can switch from an MCLR to a repo loan by paying a processing fee to your bank for refinancing. You can also make a balance transfer to another bank that offers you better terms. The second option may involve slightly higher costs for loan processing and mortgage registration. An important point you need to be aware of here is that new home loans from banks will not be tied to MCLR. They will all be linked to the repository.

MCLR Loan Rate Reset

MCLR loans can be reset in three, six or twelve months. The agreement is between the borrower and the lender. If you have an MCLR loan, check your loan agreement to find out when your next reset is.

To finish

Wondering if you want to stay with MCLR or not? Well…it all depends. For example, you have an annual MCLR reset and your next reset is still 10-12 months away. You can continue to enjoy fixed rates during this time as rates rise elsewhere. But if you have an upcoming reset, your rate may increase based on market movements.

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If you want to reduce your EMI expenses for MCLR loans, you can always do so by prepaying your loan or increasing the term of the loan. You can also opt for a balance loan transfer. But before opting for any of these options, it would be wise to do your math and stick with the one that helps you save more and get out of debt faster.

(Disclaimer: The opinions expressed in this column are those of the author. The facts and opinions expressed here do not reflect the views of www.timesnownews.com.)