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COVID-19 impact: What RBI's emergency rate cut means for your loans, fixed deposit investors

The RBI, today, cut the repo rate and reserve repo rate by 75 basis points and 90 bps, respectively (100 basis points/bps = 1 per cent). The repo rate now stands at 4.4 per cent and reserve repo rate at 4 per cent.

, ET Online|
Last Updated: Mar 27, 2020, 11.25 AM IST
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To calm the nerves of a stock market gripped by bears and to help liquidity conditions in the economy, the Reserve Bank of India (RBI) governor, Shaktikanta Das cut key policy rates on Friday. This rate cut intervention by RBI has come after central banks across the world announced rate cuts to stave off a coronavirus-related recession.

Although this might soothe the nerves of equity investors and reduce EMIs for borrowers, this is just more bad news for fixed deposit (FD) investors.

The RBI, today, cut the repo rate and reserve repo rate by 75 basis points and 90 bps, respectively (100 basis points/bps = 1 per cent). The repo rate now stands at 4.4 per cent and reserve repo rate at 4 per cent. The apex bank last cut rates in its October 2019 monetary policy review. This monetary policy review of the RBI was rescheduled in wake of pandemic which originally scheduled to take place on March 31, 2020 and April 3, 2020.

Here is a look at how today's rate cut will impact fixed deposit (FD) investors and borrowers, both existing and new.

Interest income from FDs likely to fall further
The latest rate cut is likely to cause more heart ache for FD investors, especially senior citizens who are dependent on interest income. Despite RBI keeping key rates unchanged since December 2019, major banks have continued cutting interest rates on fixed deposits. The country's largest bank, State Bank of India (SBI), has reduced fixed deposit rates back-to-back in February and March.

According to a Times of India news report, this is the first time that the SBI's fixed deposit rates have fallen below 6 per cent since August 2004.

So, what should fixed income investors do now? Where should they invest?

Those investors looking for fixed income avenues, can consider investing in small saving schemes as an option. These include National Savings Certificates (NSC), Kisan Vikas Patra, Post Office Term deposits etc. At present, these schemes are earning more than FD rates offered by some of the big banks.

Further, if you are looking for a fixed income avenue, now is the right time to consider small savings schemes, as interest rates on these products are due for review on March 31, 2020. There is a likelihood that interest rates on small savings schemes will be reduced given the current state of the economy. However, remember that most of the higher yield small saving schemes come with long lock-in periods.

Impact of the rate cut on borrowers
The unexpected rate cut is likely to reduce equated monthly instalments (EMIs) of borrowers, and also make it cheaper to take new loans.

Here's an example of how your home loan is likely to be impacted under the new external benchmark regime.
Loan Amount (₹)

3000000

Tenure (Years)

20

Current Interest Rate (%)

7.95

Current EMI (₹)

24999.92

New Interest rate (%)

7.20

New EMI (₹)

23620.47

Cut in EMI (₹)

1379.45

SBI's term loan interest rate for a loan up to Rs 30 lakh for male, salaried borrower. The interest rate is linked to repo rate.

Here's what different types of borrowers can do after today's rate cut.
Existing borrowers
A) With loans linked to external benchmark
Borrowers whose loans are linked with an external benchmark. i.e., repo rate, treasury-bills etc. as mandated by the RBI can expect to see their EMIs coming down in the next three months. This is because as per RBI's circular on linking of loan interest rates to an external benchmark dated September 4, 2019, the rates have to be reviewed and reset by banks atleast once every three months.

Therefore, today's rate cut will lower a borrower's EMI outgo in the next three months. This is the second time RBI has cut the repo rate after the new lending rate regime came into effect from October 1, 2019.

B) With loans linked to MCLR
Borrowers whose loans are linked to the marginal cost-based lending rate (MCLR) will benefit only when their bank reduces loan rates. This is because MCLR is dependent on not just external factors such as rate cut but also on the internal factors of the bank. Further, the reduction in MCLR will translate into lower EMIs only when the reset date of your home loan arrives.

Usually, a bank offers home loans with reset period of six months or one year. On the reset date, your future EMIs will be calculated on the basis of the interest rate (bank's MCLR plus margin of the bank) prevailing on that date (i.e. reset date).

Recently, SBI reduced the MCLR by up to 15 bps with effect from March 10, 2020.

If you want to switch from an MCLR-based loan to an external benchmark one, then you can do this by paying an administrative cost. However, financial planners suggest that one should make a switch only if the interest rate difference between the two is 0.50 per cent or more.

B) With loans linked to base rate or BPLR
Borrowers whose home loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR) should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of policy rates in comparison with base rate and BPLR rate-linked loans, as per financial planners and industry experts.

New borrowers
The latest rate cut will make taking new loans cheaper. While availing a loan linked to an external benchmark, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the cheapest interest rate.

Also, keep in mind that when RBI starts to hike key rates, your interest rates will go up in tandem. So external benchmark linked interest rates are likely to be more volatile than the MCLR linked rates.

Further, if you are planning to take a home loan, then check if you can avail the benefit of credit subsidy available under the Pradhan Mantri Awas Yojana (PMAY). Middle income group - I (MIG -I) with income between Rs 6 lakh and Rs 12 lakh can avail interest subsidy of 4 per cent whereas middle income group - II (MIG -II) with income between Rs 12 lakh and 18 lakh can get interest subsidy of 3 per cent under the scheme. The benefit of interest subsidy for both the groups is available till March 31, 2020.
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