“Sharp MCLR Cut brings relief to the home loan borrowers” read one of the news posts. On top of it, the senior management of the banks appealed existing home loan borrowers to shift to MCLR to take advantage of MCLR cut. I received large no of queries on my blog on how to take benefit of MCLR cut. In certain cases, wherein i suggested the readers that they will not be benefited immediately, i received some angry reactions :). The readers thought that i am trying to mislead them. But once they approached the bank and clarified the points shared by me, their apprehensions were gone :).
Let me clarify that i have already discussed almost all the points to be discussed in this post in my earlier posts. As these points were discussed in bits and pieces & may be in some other context, therefore, i thought of compiling all the points in the single post. Secondly, this post is an attempt to put all the points from the perspective of MCLR cut. The reason being, MCLR cut is a hot topic these days :). Unlike other news articles, my objective is not to create sensationalism but to provide RIGHT PERSPECTIVE to the readers of this blog. It will help the readers in taking right financial decision.
MCLR Cut – 7 Myths and Misconceptions Among Home Loan Borrowers
As i shared in my post, Marginal Cost of Funds Based Lending Rate that MCLR is the benchmark rate for all the new home loans sanctioned on or after 1st April 2016. In my opinion, one of the key reasons for confusion among home loan borrowers is too much communication from bank’s end. At the same time, there are no efforts to educate and make the borrower aware on how the home loan interest rate is fixed. I suggest the reader’s to go through my posts under Home Loan category. This topic may sound simple and easy but on the contrary, it is more complex in nature. Let me try to explain as a layman the 7 most common myths and misconceptions among home loan borrowers.
1. New and Existing Home Loan Borrowers are treated equally:
It’s a biggest misconception that new and existing home loan borrowers are treated equally by the home loan provider. There are multiple factors to be considered. As i explained in my earlier posts that banks are in the business of deposit and lending. In layman language, they mobilize funds through deposits and then lend same funds after adding their margin hypothetically say 3%. This is the justification given by banks i.e. differential cost of funds to explain the difference between interest rate for new and existing borrowers.
For example, Mr. A availed the home loan in 2014 at 9.75%. At that time the cost of funds was 6.75% and bank added it’s margin of 3%. Now today the cost of funds for banks is reduced to 5.65%. Therefore, the home loan interest rate for the new borrower is 8.65%. In short, the new and existing borrower will be paying a differential interest rate.
I discussed this concern in detail in my following posts
2. I am an existing borrower with MCLR linked home loan. My home loan interest rate should decrease immediately:
Another key concern of existing borrowers on MCLR is why i am not getting the immediate benefit of MCLR cut? The answer is that reset period under MCLR is One year for the SBI home loan. Though reset period of Kotak Mahindra Bank is 6 months and whereas HSBC home loan reset period is 3 months. A general observation is that the interest rate of banks with shorter reset period is HIGH. The max reset period allowed by RBI is one year. For example, if i availed SBI home loan on 1st Dec 2016 then my interest rate will remain fixed till 30th Nov 2017. Therefore, any benefit of MCLR cut from 1st Dec 2016 to 30th Nov 2017 will be passed to the borrower only on 1st Dec 2017. The borrower has to wait till next reset date for lower interest rate due to MCLR cut.
3. My home loan is from Housing Finance Company like HDFC Ltd, Indiabulls etc. Post MCLR cut, my home loan interest rate should decrease immediately
Please note that MCLR is the benchmark rate only for Banks governed by RBI. If you availed home loan from housing finance company then the home loan is linked to BPLR or RPLR. This confusion is more predominant among the home loan borrowers of HDFC Ltd. After the MCLR cut by HDFC Bank, readers asked me when they will get the benefit. As i explained in following post that HDFC Bank and HDFC Ltd are 2 different financial institutions. HDFC Ltd is not governed by RBI and is an HFC.
Recently, HDFC Ltd has increased the spread over RPLR (16.30%) to 7.60% so that new customers can avail home loan at 8.70%. Unfortunately, there is NO cut in RPLR to pass the benefit to existing borrowers. On the other hand, in the case of banks though the MCLR cut benefit will be passed with a delay (on reset date as i explained in point no 2) but the benefit will be passed to existing borrowers. This is the reason why i prefer home loan from banks compared to housing finance companies. Whereas in the case of HFC, most of the times you have to conversion fees to reduce the home loan interest rate.
Lastly, another common query from borrowers of HFC’s is how can they shift from RPLR or BPLR to MCLR? The answer is NO to this question. As i explained MCLR is the benchmark rate of banks. The home loan from HFC will be always linked to BPLR or RPLR.
4. MCLR cut is directly proportional to Home Loan Interest Rate Cut for new borrowers:
It is true for existing home loan borrowers but not for new home loan borrowers. For example, before MCLR cut SBI’s MCLR was 8.90% and spread was 0.25%. Therefore, the net home loan interest rate was 9.15%. Now the bank cut the MCLR (One year) by 0.90% and new MCLR is 8%. Ideally, the home loan interest rate for new borrowers should be 8.25% but it is not the case. Bank has increased the spread over MCLR from 0.25% to 0.65%. Therefore, a decrease of 0.90% in MCLR was offset by 0.40% increase in spread. The benefit to the new home borrower is only 0.5% i.e. interest rate reduced from 9.15% to 8.65%.
On the contrary, this statement is true for existing borrowers. For example, i availed home at 9.15% on 1st Nov 2016. On the date of reset i.e. 1st Nov 2017 my home loan interest rate will be reduced equivalent to MCLR cut i.e. 0.90% assuming no more MCLR cut till 31st Oct 2017. The reason being spread offered by SBI to me i.e. 0.25% will remain fixed for home loan tenure. Therefore, my home loan interest rate will be 8.25% from 1st Nov 2017
5. My home loan is linked to Base Rate of the bank. I will shift to MCLR to reduce my home loan interest rate:
It is not a correct understanding. I explained it in detail in my post, why banks are forcing existing Home Loan borrowers to switch to MCLR? To conclude, there is NO immediate financial benefit of switching from base rate to MCLR. On the contrary, the disadvantage is that under base rate the home loan reset date is every 3 months whereas MCLR reset period is one year. In the case of the short reset period by banks like HSBC, the interest rate offered is high. In some cases, banks are misleading borrowers to switch of MCLR and there are NO charges for same. The statement from bank executive is correct but they are not informing the borrower that home loan interest rate will remain same.
Therefore, if you shift from base rate to MCLR your home loan interest rate will remain fixed for one year. Here i am assuming that borrower is not willing to pay the conversion fees. If you continue with a base rate then your home loan interest rate will come down with a base rate cut. Also remember that currently only 15% home loans are linked to MCLR. I have the explained the reason of same in my last post in Home loan section i.e. why it is beneficial to stay with the base rate?
Last but not the least as i keep highlighting that transmission under MCLR is faster compared to the base rate. I understand that currently borrowers on base rate are inclined to shift to MCLR but any such decision should be financially wise. Also keep in consideration that when the interest cycle will reverse then interest rate under MCLR will increase at a faster rate compared to the base rate.
6. To reduce the home loan interest rate by paying conversion fees is financially beneficial:
I explained this topic in detail in my post home loan conversion fees. Just to add that whether to pay conversion fees or not, the decision varies from case to case basis. It depends on various factors as i explained in my other posts. Though some of the experts give basic thumb rule to decide but at the macro level, these are only assumptions.
Currently, banks are charging 0.5% of the balance outstanding + service tax to reduce your home loan interest rate. For example, if i paid Rs 30,000 towards conversion fees then i need to calculate for how long it will take me to recover this upfront cost from savings through home loan interest. I will be assuming a status quo in terms of interest rate, prepayment, balance home loan tenure etc. Therefore, it is advisable to do a cost-benefit analysis before you take any such financial decision.
7. Balance transfer from HFC to Bank is financially beneficial to take advantage of MCLR cut:
It is not correct decision always. You should not take any financial decision in haste. It is always a marketing strategy of home loan providers to churn the customers from competition to complete their targets. Please note that balance transfer is not financially wise decision in most of the cases because of cost and operational hassles. You might have observed that normally i suggest borrowers pay conversion fees instead of the balance transfer. Only in case the existing HFC’s or banks are adamant not to reduce home loan interest rates or interest rate is too high, it makes sense to balance transfer.
Also, it is not wise to expect that all the banks or HFC’s will react immediately on MCLR cut. Normally, market leaders like SBI take the lead and other follow the suit in some time. Therefore, you should always give some time to your bank or HFC to react. For example, as i mentioned currently HDFC Ltd is not offering reduced interest rates to existing borrowers even on payment of conversion fees. Based on the response from HDFC Ltd some readers asked me whether they should shift to SBI. My answer was negative. The reason being, it is too early to decide. I can assure that HDFC Ltd and other HFC’s will definitely come up with conversion fees offer. They will match the interest rate of existing borrowers on payment of conversion. Have patience and wait for 2-3 weeks time.
Words of Wisdom:
My suggestion to home loan borrowers is not get carried away by sudden developments like MCLR cut. Be financially wise. Please do your calculations before you take any financial decision. Always remember that interest rate is a cyclic process. The interest rates never remain either too low or too high. The macroeconomic indicators always balance it out. In the case of reversal of interest rate cycle, the borrowers shifting from base rate to MCLR will regret their decision. In my opinion, it is prudent to wait for a base rate cut before you decide to shift to MCLR.
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