Homebuyers look for home loans to aid the financing of a ready-to-move or under-constructed property. The loans are sanctioned at an interest rate charged by the lenders for an agreed period or loan tenor. The interest rate is the most important factor for your home loan. The interest rate is determined by your repayment ability and the repo rate fixed by the central bank of the country.
The interest rate charged on home loans is of two types- fixed and floating interest type. When the interest rate remains constant for the entire loan tenor it is called a fixed interest rate whereas, in the case of the floating type, the interest rate keeps changing every three months and is linked to the repo rate. When home loans are linked to repo rates, they are known as repo-linked lending rates or repo-linked home loans.
Since October 2019, the Reserve Bank of India (RBI) has made it mandatory for all floating rates home loans and other retail loans from lending institutions to be linked to an external benchmark. Most of the banks and financial institutions have used the repo rate as the external benchmark for their home loans. Home loan interest rates at Bajaj Housing Finance are linked to external benchmarks, such as the repo rate, providing beneficial loan terms to borrowers.
What is Repo Rate & Repo Linked Home Loans?
Repo rate is the interest rate at which commercial banks borrow money from the central banks of the country. The RBI regulates the repo rate to check the inflation and growth of the economy. It increases the repo rate during inflation to limit the borrowings of the banks, which ultimately reduces the money supply in the economy and keeps the economy afloat. The RBI may decrease the repo rate when the inflation is well under control to thrust the money into the economy to increase spending.
Repo linked home loan is a home loan scheme introduced by banks and financial institutions according to the regulations of RBI. Under this loan scheme, the floating rate of interest for home loans is pegged at the repo-linked lending rates (RLLR) instead of the minimum cost to the lending rate (MCLR). Thus, any changes in the repo rate will directly affect the floating interest rate for home loans.
How is Repo Rate Calculated for Home Loans?
When banks and financial institutions lend home loans on RLLR, the interest rate is the floating type. Here the interest rate is composed of RBI’s repo rate or reset frequency and spread or margin. Reset frequency is based on the repo rate as per the RBI’s directive and has a maximum period of three months. Spread or margin is the extra amount that the lending institutes charge to cover credit risk, profit mark-up, etc. The amount of the spread may differ from one lender to another, but it remains constant for the home loan borrowers for the entire loan tenor. When the reset frequency moves up (during increased repo rate), your interest rate will also increase and you will have to pay a higher EMI. On the other hand, if the interest rate moves down, your EMI is also reduced.
The banks and lending institutions are allowed to fix a risk premium depending on the borrowers’ profile and other terms and conditions of the lending institutions. Risk premium provides an upper hand to the lending institutions to fix charges according to their standards and procedures. The borrower’s credit score, source of income, job stability and security, and loan-to-value (LTV) ratio determine the risk premium. Therefore, the risk premium will vary from one borrower to another. For example, if your credit score is below 700 and you want to avail a home loan in India for Rs.40 lakhs, you will be seen as a risky borrower, and the lending institution will increase the risk premium, say by 0.60 per cent (based on their terms and conditions). Thus, you will be charged an interest rate of 7.5 per cent (the minimum interest rate) plus 0.60 per cent i.e., 8.10 per cent.
The floating rate of interest for a home loan is directly linked with the repo rate, so any increment in the repo rate will simultaneously increase the lending rates by the same percentage. The lenders are assigned a maximum term of three months to shift the interest regime for a floating rate of interest. Therefore, any changes in the repo rate will reflect in the borrower’s account after three months since the time of lending. For example, if you have availed of a home loan of Rs.50 lakhs at 8.25 per cent floating interest rate for 20 years tenor and after 2 months the RBI decreases the repo rate by 50 basis points (bps), then your home loan rate in the above instance will come down by 50 bps i.e., 7.75 per cent. The payable EMI will change after one month, as the reset frequency of RLLR is three months. Here the payable EMI will be Rs.42,603 to Rs.41,047.