Understanding MCLR and Its Impact On Indian Home Loan Interest Rates 2023

MCLR is the new buzzword in the finance world. But what exactly is MCLR? And, how will it affect your home loan interest rates in 2023?

Read on to know more.

What is MCLR?

To improve the lending rate system, the Reserve Bank of India introduced the MCLR – Marginal Cost of Funds-based Lending Rate in 2016. This new set of guidelines was introduced with the intention that banks pass on the benefits of rate cuts to borrowers.

Earlier, interest rates charged by the banks largely depended on the base rate system. Base rate is the rate below which banks cannot extend loans to the borrowers. However, after April 2016 MCLR was introduced which became the internal standard rate of banks for extending loans.

How does MCLR affect home loans?

Before we understand this, we need to understand a few key points. 

The Key Components of MCLR calculations:

MCLR is dependent on multiple factors which are collectively considered to fix the interest rate.

• Marginal cost of funds – This element depends on factors like interest rate given on short-term interest rate or repo rate (the interest rate at which commercial banks borrow money from the Reserve Bank of India), term deposit, savings accounts return or net worth, and so on.
• No return on Cash Reserve Ratio (CRR) – Banks do not get any interest on cash reserves kept with RBI
• Operating costs – Cost sustained by the banks towards their operation
• Tenure premium – The more the tenure or period of a loan repayment is, the greater the risk associated with it. To mitigate the risk of losses, the bank charges a higher interest rate in the form of a premium. This is called the tenure premium.

Types of loans linked to MCLR

All the loans with a floating interest rate are linked to the MCLR rate. The following loans are placed under MCLR:

• Home loan
• Corporate term loan
• Loan against property

The impact of the implementation of MCLR

Before MCLR, the interest rates were determined by the repo rate. Earlier, when RBI reduced repo rates, banks took a long time to reflect it in their lending rates for the borrowers. However, after the implementation of MCLR interest rates, banks must adjust their interest rates as soon as the repo rate changes. MCLR brings more transparency in the structure followed by the banks to calculate interest rates.

How does MCLR differ from Base Rate Systems?

MCLR can be said to be an improved version of the base rate. It is a risk-based approach that decides the final lending rate of the borrowers. It takes into account unique factors like the marginal cost of funds rather than the overall cost of funds.

The marginal cost considers the repo rate which did not form part of the past rate. When calculating the MCLR, banks must incorporate all types of interest rates that they sustain in mobilising the funds. Previously, the loan tenure was not considered while determining the base rate. However, after the implementation of MCLR, banks are required to take into account a tenure premium. It allows banks to charge a higher rate of interest for long-term loans.

How does MCLR function for existing home loan borrowers?

Existing home loan borrowers can request their banks to link their loans to MCLR. It could be more beneficial as MCLR has usually a lower rate than the base rate on a home loan. However, home loan borrowers must give a moment to make any decision because once your home loan is linked to MCLR, it cannot be reversed to the base rate.

MCLR in 2023

The current repo rate stands at 6.50 percent which has been kept unchanged by the Reserve Bank of India since the latest Monetary Policy Committee meeting in August 2023. It has been seen as a welcome move and a relief to home buyers. In the previous year, due to the rise in the cost of raw materials, the housing units observed a surge in the price. However, this year as the lending rates are unchanged until any further announcements by the RBI, homebuyers can search for their favourable home purchase deals.

If you are planning to make the MCLR switch, kindly go through the related fees and charges which vary for different banks.