What Is Repo Rate and How it Impacts Home Loans

Financial institutions price home loans according to a benchmark, internal or external. To introduce transparency into the process of determining interest rates, the RBI introduced the Marginal Cost of Funds based Lending Rate (MCLR) in 2016.

However, since the MCLR was also dependent on several factors, and not just the RBI’s lending rate, the MCLR did not prove to be as fruitful as desired. So, in order to bring about greater transparency in the lending process, the RBI introduced the external bench marking system, which requires banks to arrive at an interest rate based on any of the eligible external benchmarks. This new system is particularly beneficial to borrowers and it assures you of better transmission of policy rate cuts.

As per the directives from the RBI, banks must link retail loans to one of four external benchmarks from 1 October 2019 onwards. In response to this move, most banks have picked the RBI’s repo rate as their benchmark. While Non-Banking Financial Companies (NBFCs) can continue to price home loans according to existing protocols, the competition in the market will not allow them to stay far from the rates offered by banks. Hence, the repo rate plays an indirect role in NBFC interest rates too.

Now that you know how home loan interest rates are linked to the RBI repo rate, it is good to understand the repo rate in further depth. Read on to know all about it.

Repo Rate: Its working and impact on the economy

Repo is short for Repurchasing Option and the repo rate is the rate at which the RBI lends money to financial institutions. As per the Repurchase Agreement, banks obtain loans from the RBI by providing securities. The repo rate is effective in regulating the country’s economy. For instance, in times of inflation, the RBI works to reduce the flow of money in the economy by increasing the repo rate. This way financial institutions tend to borrow less and increase the rates of interest on loans. In the same way, the RBI lowers its repo rate to boost the country’s economy and increase liquidity.

Repo Rate and reverse repo rate: How do they differ?

The rate at which the RBI borrows money from financial institutions is termed as the reverse repo rate. Here, financial institutions park excess funds with the RBI and benefit from the interest received on the deposits. This translates to reduced cash flow in the country as the lenders no longer have surplus funds. In case of a decline in the reverse repo rate, lenders deposit less with the RBI and lend more to borrowers. Likewise, when the repo rate increases loans tend to get expensive and conversely, you can enjoy affordable loans when the repo rate dips.

Repo Rate and EMIs: How they are related?

A low repo rate translates to low home loan interest rates and hence, pocket-friendly EMIs. Similarly, a high repo rate translates to high home loan interest rates and therefore, weightier EMIs. This means that you can save on your EMI outgo by availing a home loan at a time when there is a drop in the repo rate. The current repo rate stands at 5.15% and financial institutions under the external benchmark regime are required to reset their lending rates at least once in three months.

EMIs and current Repo Rate: What are the implications?

Based on the economic conditions of the country, the RBI tends to change its repo and reverse repo rate. If you have taken a floating interest rate home loan, then changes in the RBI’s repo rate will impact you. At present, the repo rate stands at 5.15% and the reverse repo rate at 4.9%. Should the RBI announce a repo rate cut, you may land up paying smaller EMIs. If you have taken a loan with a bank and the interest rate is linked to the repo rate, you can expect lower home loan interest rates when the rates are reset. If you have partnered with an NBFC you should hope that your lender brings the rates offered on par with the current ones offered by banks.

In the event that you have taken a fixed interest rate loan, then changes to the current repo rate have no bearing on your EMIs. Your interest rate remains fixed, through the entire tenor.

Having considered what the RBI’s repo rate is and how you can benefit from rate cuts, explore home loans that are priced reasonably.

Also Read: How does the change in RBI repo rate influence your loans?