Pay attention to the markup in the home loan interest rate

Interest rates are rising in lockstep with the repo rate. But the markup on those loans has dropped to a three-year low. For example, if a bank offers home loans at 8.40% interest when the repo rate is 6.50%, it means a markup of 190 basis points on the repo – a sharp decline from March 2020 when the lowest markup was 275 basis points. Was. A basis point is one hundredth of a percentage point. With the repo rate increasing from 4.00% to 6.50% now, it has converted a 20 year home loan into 35 years. Loans issued prior to 2020 have significantly higher markups than loans issued more recently. Therefore, a drop in markup gives homeowners an opportunity to get out of debt faster. How? By refinancing at a lower rate – and therefore a lower markup. Let us understand this phenomenon better.

the markup you pay

A typical home loan rate consists of a benchmark rate and a markup. For example, a large public sector bank says its minimum markup over repo is 265 basis points. So 6.50 (current repo rate) plus 2.65 (markup) equals 9.15, which is the lowest home loan rate of this bank. The markup is shaped by factors such as the borrower’s credit score, source of income, loan size, and often their gender. The more credible you are, the lower your markup.

What’s up with the markup?

Since October 2019, banks have benchmarked retail lending rates for repos. With this, the markup started declining. The repo stood at 5.15% in early March 2020. The lowest home loan rates then ranged between 7.90% and 8.60%, indicating a markup of 275-350 basis points. By March 2022, the lowest markup on the repo was reduced to 240 basis points. In March this year, it came down to 190-200 basis points.

Why does markup matter?

Repo benchmarking has curtailed the discretionary rights of banks in resetting floating rates on outstanding loans. Now, any change in the repo rate is met with an equal change in your lending rate once every quarter. But only the benchmark rate should change within your rate. Your markup—and this is important—must remain fixed for the term of your loan. RBI allows banks to increase the markup only if the credit score of the borrower decreases during the course of availing the loan. The new benchmarking regime has heated up home finance. Like the repo rate, interest rates moved up sharply. Therefore, in order to price their loans competitively, banks slash their markups. Therefore, as interest rates on outstanding loans have risen above 9.00%, new loans are being issued at less than 8.50%. This huge gap presents an opportunity for homeowners.

How does the low markup help borrowers?

Thanks to repo benchmarking, we saw a sharp and immediate fall in home loan rates in 2020. By 2021, we will have a majority of lenders at sub-seven rates, which was previously unimaginable. Home financing just got cheaper. Now, consider a loan with a markup of 190 basis points. If the repo rate falls to 4.00% someday, the loan will cost only 5.90%. If you’re on an older loan with a very high markup, it makes sense to refinance to a lower rate. Not only are you locking in a lower rate and spread, you will also be out of debt once the repo is reversed. Let’s say you took out a home loan at 9.50%, which you refinanced for 20 years at 8.50%. If the repo rate is reduced to 5.50% within one year, your loan rate will drop to 7.50%. With constant EMIs (Equated Monthly Installment), your loan tenure will come down to around 17 years without any prepayment.

Note that rates are cyclical. But if you’re a prime borrower with a high credit score, steady income and standard loan payments, and are still paying a high markup, consider refinancing. A low markup will be key to getting out of debt quickly.

Adil Shetty is the Chief Executive Officer, BankBazaar.com