How to reduce your home loan interest rate
With the current reduction in MCLR, this may be the best time to re-negotiate and switch your loan over to the MCLR system.
On January 2, 2017, one of my friends called me in excitement. “SBI has reduced the home loan rates to 8%. Seems HDFC is just fleecing me still at 9.75%. How do I shift my home loan?” There are some inherent fallacies here and let’s see what really happened to home loan rates and what should be your next steps to benefit from the current cuts in lending rates.
Banks now follow a MCLR (marginal cost of fund-based lending rate) model whereas HFCs (housing-finance companies) continue on the PLR (prime-lending rate) model. The MCLR is the benchmark rate below which a bank cannot lend and is calculated based on a prescribed formula based of four variables (a) marginal cost of funds (b) operating cost (c) tenure premium and (d) negative CRR-carry cost.
MCLR replaced the earlier base rate system, which, in turn, had replaced the PLR in banks. The objective of these shifts by the regulator (RBI) has been to move to a more transparent, quantitative and market-determined rates. Thus MCLR is a more dynamic model reflecting the incremental cost of funds and changes on a monthly basis. All new home loans taken from a bank with effect from April 2016 are on MCLR. But prior home loans would be on base rate or the PLR, which will be slower (read ‘very slow’) to react to changes in the interest rates. Home loans from HFCs like HDFC still work on the PLR model.
Due to the formula system of MCLR, SBI had to cut its MCLR from January 1, 2017, from 8.9% to 8%. SBI did not pass on this entire reduction of 90 bps to customers. Concurrently, it increased the margin on top of MCLR. Thus new home loan rates fell by around 50 bps and now will be in the range of 8.6%-9.1% depending on the ticket size and type of loan.
Being on an MCLR system provides home-loan customers with a more dynamic interest rate environment and is beneficial to customers. When one takes a home loan linked to MCLR, one should remember that the interest rate changes only on a pre-determined reset date. Between two reset dates, an MCLR home loan works like a fixed rate loan oblivious to any changes in the MCLR. RBI allows banks to have a reset period up to a maximum of one year.
For example, SBI has a reset period of one year, whereas HSBC has a reset period of 3 months. Thus a home loan customer who had taken a loan from SBI in Dec 2016 say at 9.3%, will not have any benefit of the current reduction in interest rates till December 2017, but new customers will be eligible for lower rates. Ideally one should choose a lower reset period to have a truly floating home loan.
What happens if you are on base rate or PLR model. Either you should move over to the MCLR model (which is a mandated option you have, though your bank may charge you for it) or wait for the base rate/PLR to come down.
SBI in the past 15 months has reduced its base rate by 5bps and the MCLR in the last nine months has reduced by 1.2% showing the reluctance of banks to cut base rates and thus not passing on the benefits of lower rates to existing customers. With the current reduction in MCLR, this may be the best time to re-negotiate and switch your loan over to the MCLR system. If you are with an HFC like HDFC, you could negotiate with your home-loan provider to shift your interest rates down to the prevailing market rates or shift over to a bank on the MCLR system. Every day of delay costs you money lost in higher interest.