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State Bank of India (SBI) has announced a massive reduction in its base rate, from 8.95 per cent to 8.65 per cent, effective from January 1, 2018. With other banks expected to follow suit, will it result in lower EMIs for the existing borrowers? Will you be able to borrow at this reduced rate, if you are planning to take a home loan from SBI this year? Will it result in lower home loan tenures, if you have already borrowed money from the bank?
What is the base rate?
The base rate is the minimum rate, below which the banks are not allowed to lend, even to the borrower with the best credentials. Prior to the base rate regime, banks and home finance companies used to lend with a premium or discount, to what was called as a ‘Primary Lending Rate’ (PLR). Under the PLR regime, the lender was free to lend at rates below or above the PLR rate. Hence, borrowers would never be able to judge, whether they got the best deal as it was not transparent. Moreover, the banks were not quick to pass on the benefit of reduction in the Reserve Bank of India’s (RBI’s) policy rates. So, to bring transparency in the lending rates, the RBI mandated that all the banks should benchmark all their loans against a base rate, below which the banks will not lend to any borrower, from July 1, 2010.
As the base rate was based on the average of aggregate cost of borrowing of the banks, reductions in the repo rate did not translate into immediate and corresponding reduction in the costs of funds for the banks. Hence, the changes in the base rate did not reflect the change in the official repo rate. Please note that the housing finance companies still lend under the PLR regime.
SBI’s base rate cut: What it means for new borrowers
After the base rate regime came into operation, the RBI observed that the lenders were not so quick, in passing on the benefits of reduction in its policy rates. While the RBI announced reduction of 1.75 per cent in its repo rate between January 15, 2015 and September 29, 2015, the banks had passed on only up to around one per cent to the borrowers, by way of reduction in their base rates. For example, SBI reduced its base rate from 10 per cent to 9.30 per cent, during the corresponding period.
To ensure the quicker passing of the reduction in their lending rates, in line with the policy rates, the RBI mandated that all lending after April 1, 2016 should be benchmarked against the Marginal Cost of Funds-based Lending Rate (MCLR). The RBI also instructed banks to provide an option to borrowers, to shift from base rate regime to the MCLR regime. So, all the home loans given by banks after April 1, 2016, were benchmarked against the new MCLR regime.
So, the announcement the latest major reduction in the base rate by SBI, will affect the borrowers who have availed of their home loans, between July 1, 2010 and March 31, 2016 and who have not shifted to the MCLR regime till this announcement. It is interesting to note that although the SBI has announced a reduction in its base rate, it has not announced any reduction in its MCLR. So, only the borrowers who had borrowed under the base rate regime, will get the benefit of the reduction in base rate by SBI.
Options available to SBI home loan customers
If you have borrowed under the base rate regime, you have the option to shift to the MCLR regime, on payment of some processing free of around one per cent of the outstanding loan amount. From the correlation between the changes in the repo rate and the base rate, during the period when the RBI’s repo rates were reduced, it becomes clear that the pace of change in the base rate was slow. Since the MCLR is based on the marginal cost of borrowings of funds, the pace will be equally fast when the cost of the funds for the banks goes up and thus, the banks will be forced to increase their lending rates, once the cost of borrowing goes up.
The liquidity, which became available to the banks after demonetisation, has dried up and the banks have been forced to increase the interest which they pay to their deposit holders. This is evident from the recent announcement of SBI, to increase its deposit rate with effect from November 30, 2017, by one per cent. Due to fears of a surge in inflation, the market perceives that the RBI will keep its repo rate unchanged in the short term. Hence, with no action expected from the RBI and increase in the deposit rates by banks, it is expected that in the current year, the banks will be forced to pass on the cost of their interest rates by quicker increase in their MCLR. Moreover, as the change in base rate is not so quick, the borrowers who have borrowed under the base rate regime and who have not yet shifted to the MCLR regime, should not hurry to shifting to the MCLR regime, as any increase in the base rate will be slower, for the next year.
Base rate reduction: Should you reduce your EMI or the loan tenure?
With any reduction in the interest rates, banks generally do not change the EMI of your home loan and this results into an automatic reduction in the home loan tenure. If you want to reduce your home loan EMI, with the reduction in the interest on your home loan, you need to approach your lender. Should you opt for a reduction in your EMI, in such a situation?
Ideally, you should not change anything and continue to pay your pre-existing EMI. This is because the home loans is generally for a tenure of 20 years, during which time the interest rates may undergo a minimum of three cycles. During these interest rate cycles, your home loan interest may go up, as well as go down. So, it is not advisable to change your EMI, with each change in the interest rate cycle.
(The author is a taxation and home finance expert, with 30 years’ experience)