RBI Reduces The Interest Rates On Home Loan

Interest rates on home loans offered by banks are now linked to an external benchmark. This is because the Reserve Bank of India (RBI) has asked all scheduled commercial banks (except regional rural banks), local area banks and small finance banks to link interest rates on retail and MSME loans to an external benchmark rate with effect from October 1, 2019. RBI, in its circular, has directed banks to link their retail lending interest rates to any of the following external benchmarks:


> RBI's repo rate

> Government of India 3-months Treasury bill yield published by Financial Benchmarks India Pvt. Ltd. (FBIL)

> Government of India 6-months Treasury bill yield published by FBIL

> Any other benchmark market interest rate published by the FBIL


Borrowers paying EMIs on their floating interest rate private home finance have nothing to cheer about as the Reserve Bank of India (RBI) has kept the repo rate constant in its October 2020 monetary policy. However, the borrowers may expect some relief from the earlier cuts by the RBI as several banks have reduced their MCLR and repo linked lending rates in the recent past. RBI has tweaked the risk weight standards to reduce banks’ capital requirements to disburse large loans, like a typical home loan. So, what does this mean for the average home buyer?


The RBI has also taken another important step. The differential risk weights are applicable based on the size of the home loan as well as the loan to value ratio (LTV). The RBI has rationalised the risk weights by linking them only with LTV ratios for all new home loans sanctioned up to March 31, 2022. Such loans shall attract a risk weight of 35 per cent where LTV is less than or equal to 80 per cent, and a risk weight of 50 per cent where LTV is more than 80 per cent but less than or equal to 90 per cent. This measure is expected to give a fillip to bank lending to the real estate sector.


Since October 1, 2019, loans, including home loans and auto loans, offered by banks are linked to an external benchmark, which for most banks is the RBI repo rate. Currently, the home loan interest rates for new borrowers start from as low as 6.7 per cent, however, for the majority of borrowers based on the loan amount, profession, gender etc, it is 7 per cent or even higher. The margin charged by a bank will remain the same for all home loan takers, however, as per the RBI circular, banks are allowed to charge a risk premium from borrowers. Risk premium charged by the bank will depend on how risky your bank perceives you to be and will therefore vary from one borrower to another.


To categorise the borrower on the basis of credit risk, some banks have internal risk assessment teams while others rely on credit scores to grade the risk of each borrower. As per RBI's circular, if your credit score undergoes substantial changes, the bank can revise the risk premium charged on the home loan. As leading interest rates are linked to an external benchmark, banks are required to reset the interest rates at least once in three months. Therefore, any change in the external benchmark rate, will mandatorily have to be passed on to the borrower within three months of the change.


Under the previous marginal cost of lending rate (MCLR) regime, home loan borrowers and others often complained that banks did not pass on the benefit of a lower rate whenever RBI cut the key policy rates but often raised the interest rates quickly whenever policy rates were hiked. Linking the interest rates to an external benchmark is supposed to bring in more transparency and faster transmission of changes in key policy rates.


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