MCLR Vs Base Rate: What Should You Select for Your Home Loan

After demonetization by the Government of India, all the banks have reduced their loan interest rates. This is the right time to buy your dream home. When SBI has cut the MCLR by 0.9%, everybody cheers in the market. Slowly all other banks followed the same principle. Many of home loaners also started enquiring about the MCLR. The certain question which appears in everyone’s mind is that MCLR vs base rate which is beneficial.RBI introduced the Marginal cost of Lending (MCLR) on April 1, 2016, and consistently pushed banks to follow MCLR instead of the base rate for the consumer loans. Banks are continuously guided by Reserve Bank of India (RBI) to apply this rate for their loan rate calculation.

Also Read: Five Reasons Why You Should Not Prepay Home Loan

The Government of India is also encouraging the housing sector with its various schemes under Pradhan Mantri Awas Yojana Scheme and also launched the Real Estate Regulatory Authority (RERA) for transparency.

 

What is Base Rate?

The base rate is the minimum interest rate at which bank gives the loan to the consumers. Base rate depends on various factors such as deposit rate of banks, profit, the cost of banks etc. It is independent of repo rate of RBI. Bank can change base rate every quarter.

What is MCLR?

When RBI is reducing the repo rate continuously, the banks are not passing the benefit to consumers as the base rate calculation is different for different banks. Then RBI starts guiding the banks to calculate marginal cost of Lending rate (MCLR).

RBI also pushed the banks to adopt the MCLR in place of base rate to make the banking system more transparent. MCLR depends on the marginal cost of funds; cash reserve ratio (CRR), operating cost and tenor premium. MCLR can be different for the different tenure of the loan.

MCLR vs Base Rate:

Now we will know about the benefits, disadvantages of MCLR and Base Rate and should we switch our home loan from existing base rate to MCLR. Where will we get the maximum benefit?

Consider an outstanding home loan of Rs 20, 00,000 based on base rate and taken before April 1, 2016. The SBI base rate was 9.55% for Men and 9.5% for Women before January 1, 2017.

Now, the SBI has slashed the MCLR and currently it is 7.95% (One-year MCLR). SBI charges 0.40% over MCLR which put the effective interest rate as 8.35%. This MCLR is applicable for new a loan which is taken after the effect of this new MCLR.

If you change the home loan from base rate to MCLR, the interest rate will certainly go down. You can get the benefit of this new MCLR by giving conversion fee to your bank. Bank generally charges 0.5% plus tax on outstanding home loan as conversion fee.

If you have taken home loan after April 1st, 2016 and it is already based on MCLR you have to pay the conversion fee to apply the new MCLR. Most of the individual can reduce their SBI home loan interest rate with the help of this conversion.

There is an annual reset clause of MCLR available with most of the banks. According to this rule, the interest rate of the home loan is to be reset every year on the basis MCLR available at that time. Suppose you have taken a home loan on April 2016 based on MCLR available that time. This rate will be reset on every year April with the applicable MCLR at that time.

State Bank of India, ICICI Bank and Bank of Baroda are the three banks who have reduced the MCLR drastically after demonetization. The other banks have also followed the same by reducing their MCLR. As an example, IDBI bank has now 6 months MCLR of 8.35% which is applicable to the home loan. Now their base rate is 9.5%. You will get an obvious benefit by changing the home loan from base rate to MCLR.

Now before switching your loan to MCLR, contact your bank, calculate the benefits of reduced EMI or tenure with respect to conversion fee and do your cost-benefit analysis and take decision accordingly. Here you can think of balance transfer your home loan to SBI, ICICI bank. In this case, you have to remember the processing or application fee of the new loan in SBI or ICICI bank. The foreclosure charges of the existing loan are also to be checked with the home loan provider.

Also Read: How to Transfer Home Loan to Another Bank and Should You Do It?

Example:

Suppose your outstanding home loan is Rs 20,00,000 for five years and you are paying Rs 20,000 as an EMI. The interest rate is 9.5% and if you change to MCLR basis it will be 9.1%.

Suppose your outstanding home loan is Rs 20,00,000 for five years and you are paying Rs 20,000 as an EMI. The interest rate is 9.5% and if you change to MCLR basis it will be 9.1%.

Take the conversion fee as 0.5% of outstanding amount = Rs 10,000

The EMI you will save is approx. Rs 40,000 on the fifth year. But you have to pay Rs 10,000 right now. So, we have to calculate the value of Rs, 10000 at fifth year.

Considering 8% interest rate per year the value of Rs 10,000 will be Rs 14,700 at the end of 5th  year.

Hence, you can change your home loan from base rate to MCLR in this case.

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