Base Rate and Marginal Cost Lending Rate: Which One is Best to Choose?

Base Rate and Marginal Cost Lending Rate: Which One is Best to Choose?

The earning capacity of youngsters has increased with time and they no longer have to wait till their 50s to earn enough to be able to afford their own home. This is largely made possible because of the easy availability of home loans and one can choose a long tenure of up to 20 or 25 years to pay off the loan. However, According to RBI home loan guidelines there is one thing to contend with- and that is the sudden hike in home loan interest rates that happens from time to time. The latest repo hike of 25 bps by the RBI had come just after prominent banks had hiked their MCLR or the Marginal Cost of Funds Based Lending rates. The bottom line is that the EMIs would go up and one should try to look at a few things to cope with this climbing rate.

Before the MCLR was introduced, all the loans were based on the Base Rate, which was common for all the loans. The spread from the base rate was also fixed throughout the loan tenure. When the lending rates were cut by the RBI banks often gave excuses like if they brought down the new loan rates any further, then the existing loan rates would also have to be reduced. The interest rates for home loans did not go down enough even when the RBI reduced the rates quite a few times in the period between 2014 and 2016 because the banks did not want to extend the rate cuts they received to the customer. Since the RBI could not do much to make the cut reach the consumer quickly, it gave rise to the concept of MCLR.

What is MCLR?
With MCLR home loan, the banks are now linking their lending rates to the marginal funding costs- which is also the cost of fresh or incremental borrowings. So now if the bank reduces the rates on FDs, savings account etc then it must also transfer the cut in deposit rates to the lending rates. So if the borrowing rates go down, then the lending rates need to be reduced as well.

Those who are wondering whether to shift from base rate to MCLR or not will find that the latter can prove to be quite advantageous in a number of cases. For new home loan borrowers, the interest rate would be lower than the base rate and with the changes in interest cycles that could happen overnight, weekly, quarterly, in 6 months or annually, the rates could be reduced even lower. While getting a loan, make sure that the loan has a clause mentioning the interest reset period- which means any change in the interest rate would only be effective at the reset time. If you want to switch from base rate home loan to MCLR home loan, then you need to notify the bank about it and they will start the procedure. If you find that this change does not yield any significant reduction of interest for you, then you may consider home loan balance transfer with a lender which will allow you to enjoy the benefits of this reduction. However, do so only if you find that you will enjoy a significant reduction in rates even after paying the foreclosure fees in the existing bank and after paying the processing fees in the new bank.

Lenders like Bajaj Finserv and other banks have such balance transfer opportunities so make sure to enquire about their reset periods and their rates from time to time.

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