All loan interest rates are linked to a benchmark. The benchmark indicates the lowest rate at which the lender will give you a loan. Typically, your loan interest rate is calculated as benchmark rate plus credit spread.
When you borrow from a bank, your interest rate is linked to the MCLR set by the bank.
So, for example, the one-year MCLR of a leading public sector bank is 8.25%. For a home loan under Rs. 30 lakh, this bank applies a minimum spread of 10 basis points. Therefore, the lowest home loan rate applied by this bank is 8.25% + 0.10% = 8.35%.
Last year, the Reserve Bank of India asked banks to link their loans to external benchmarks. The options provided for these benchmarks were the repo rate set by the RBI, the 91-day Treasury Bill yield, the 182 =-day Treasury Bill yield, or any other benchmark produced by FBIL.
This intended to take the benchmarking away from the banks. It was necessary to ensure that when the RBI reduces its repo rate, it leads to cuts in the rates of loans provided by banks. This wasn’t the case as the rate cut transmissions weren’t effective and the rates of borrowing remained high despite several repo rate cuts.
Earlier this year, SBI became the first bank to link a home loan to the repo rate. Rather, they have created a benchmark known as the Repo Linked Lending Rate (RLLR).
Here’s how the SBI formulates the RLLR: repo rate + mark-up + spread. In the current scenario, the lowest RLLR-linked rate home loan would cost: 5.40% (the repo rate now) + 2.25% (mark-up) + 0.40% (spread) = 8.05%.
What a repo-rate linked loan does for the customer is that he no longer needs to be 100% dependent on the bank to reduce the loan rate. With a drop in the repo rate, his home loan rate will adjust immediately by the margin of the drop, while the spread will remain constant for the loan tenure. The credit spread may increase only with a change in the credit risk profile of the borrower.
Following SBI, a host of other public sector banks have announced repo rate linked loans. These include Syndicate Bank, Union Bank, and Allahabad Bank.
New home loan seekers can consider these products because they are more transparently priced and will be more reactive to RBI mandated rate cuts.