April 17, 2020

How does Repo Rate Cut Translate into Lower Interest Rates?

Repo rates have been continually declining for the past few years. In FY2019, the RBI undertook 5 repo rate cuts, the last one coming in October. Still, borrowers are often unaware about the direct correlation between repo rates and home loan interest rates.

What is repo rate?

Repo rate is the interest rate at which the RBI lends money to financial institutions after the latter sells their securities to the central financial body. Lending institutions also need to maintain liquidity, which is why they seek such advances from the Reserve Bank of India. The current repo rate stands at 5.15%. This lending rate on home loans is thus also referred to as Repo Linked Lending Rate or RLLR. Note that the previous lending rate for home loans was the MCLR and there are numerous borrowers who have existing home loans which are MCLR-linked.

Nevertheless, there is a slight difference between repo rate and RLLR. While the former is simply the interest rate at which financial institutions borrow money from RBI, RLLR refers to this rate plus spread.

RLLR = Repo rate + margin

While learning about repo rates, you may also come across the term reverse repo rate. This is nothing but the opposite of a repo rate. It refers to the interest that RBI pays to financial institutions when it absorbs the excess liquidity from the market. Such a thing happens when the central financial institution wants to restrict the borrowing power of investors.

How do repo rate cuts reduced loan interest?

RBI repo rate cuts lead to a reduction in the interest rates on all linked consumer loans. A home loan customer should understand why this happens.

As discussed previously, repo rate is the interest rate that financial institutions pay to the RBI after borrowing a sum from this central depository. Thus, when the repo rate falls, so does the liability for the various financial organisations.

Hence, HFCs can decidedly reduce the applicable interest on their home loan products because they are able to pay interest rates to the RBI and still maintain a sizable margin on their interest rates.

Keep in mind that repo rate linked home loans are the only housing credit that is affected after repo rate cuts. Still, a prospective borrower should know other avenues to reduce home loan interests.

-Ways to decrease home loan interest rates

When it comes to tips on decreasing your home loan interest, one can follow these measures.

-Improve credit score

Credit score is a measure of your creditworthiness. Generally, lenders ask for a score of at least 750 while availing loans. Nevertheless, if you hold higher credit scores, the financial institution may offer you home loans at reduced rates.

Individuals who hold below-par scores, on the other hand, need to take a few steps to improve their rating before home loan application. Clearing all outstanding debt on time, full and timely credit card repayment and limited credit utilisation are some simple ways to boost the CIBIL score.

-Apply for smaller loan quantum

Another proven way to get better home loan interest rates is to make the highest possible down payment and avail the lowest possible loan amount. Generally, borrowers who successfully meet the eligibility criteria of a lender are offered LTV up to 80%, i.e., 80% of the property’s value as a loan. The remainder has to be met by the borrower as down payment. However, if you make a down payment of 30%, you will need to avail a home loan equal to 70% of the property. Lower the loan amount, lower the risks for the borrower and you stand a chance to negotiate for easier terms on the loan.

-Choose a shorter tenor

Choosing a shorter term ensures that a borrower ends up paying lower as liable interest over the tenor. However, the same will lead to higher EMI amounts. Note that the lender will consider your repayment capacity when you choose to opt for a shorter tenor.

-Balance transfer

Home loan borrowers often utilise balance transfer options to benefit from reduced interest rates available on the market. Borrowers must, however, consider the associated charges of a balance transfer as against the lower interest outlay before going ahead.

Thus, apart from repo rate changes, these factors can help you reduce interest rates on home loans. Opt for a leading loan provider with a high CIBIL score and income to avail a home loan at the most beneficial terms.