Inflation and interest rates have remained higher for longer than expected. Homeowners stuck with elevated home loan interest rates have been hurting. Inflation continues to be volatile. There were expectations of a repo rate cut by now, but the wait has gotten longer. So, here’s a primer on what homeowners with sticky rates can do while we wait for the repo rate to fall.
Compare your rate
The lowest home loan rate on offer today is 8.3%. Many large lenders have grouped around 8.5. Ask yourself: how much of a premium are you paying over and above 8.5% for your home loan? If it’s less than 50 basis points (bps), your rate difference, while elevated under the given circumstances, may be tolerable. But if it’s above 50bps and into the 9s and 10s, it’s time to act. Consider a refinance. Hold that thought.
Check your benchmark
About 95% of home loans in India have floating interest rates. These rates have an underlying benchmark rate—essentially the reference rate basis which the final rate is calculated. Since October 2019, the benchmark for home loans is the repo rate (which is at 6.50 today). Loans given by banks between April 2016 and October 2019 were benchmarked to the MCLR, or marginal cost of funds based lending rate. Before MCLR, there was the base rate. As the Reserve Bank of India (RBI) had frequently highlighted, loan rates with older benchmarks got sticky in high-inflation periods. The RBI would cut interest rates, but consumers would receive only a fraction of the cuts. Therefore, if you’re on an older benchmark from before 2020, it’s possibly a pricier loan. In that case, consider moving to a repo-linked loan.
How repo loans help
Repo-linked loans, which banks provide, help you in two ways. One: the ‘spread’ you pay above the repo remains fixed for the loan duration. For example, if your rate is 9.00 while the repo is 6.50, your spread is fixed at 2.50.
Two: whenever the repo rate changes, your home loan rate changes by the same measure within a quarter. For example, a 25bps cut in the repo today would lead to the above loan’s rate falling to 8.75, with the spread still at 2.50. This takes away any uncertainty around when and by how much your floating rate will adjust.
Seize the low spread
It is to the consumer’s benefit that home loan spreads in 2024 have fallen dramatically from the early 2020 levels when they were 275bps to 360bps over the repo. With the lowest rates at 8.30-8.50 today, spreads are as low as 180-200bps. With the repo primed for a fall soon, customers can capture a lower spread for the rest of their loan durations, and also receive any upcoming rate cuts faster, by refinancing to a repo-linked loan. Note that interest rates are cyclical. So rate hikes, when they occur next, will also happen equally quickly.
Act if loan is with a public sector bank
RBI data (September 2023) shows that 79% of floating-rate loans from private banks are now repo-linked. With foreign banks, it’s 90%. But government banks are still only at 38%, which drags the industry average to 54%. With government banks, 57% are on MCLR and around 3% still on base rate. The takeaway is borrowers on these loans may be paying a higher rate than necessary.
Why refinancing helps
Assume you’re paying 9.50 on your loan with 10 years left. For every ₹1 lakh left on your home loan, your EMI is ₹1,294 and total interest payable is ₹55,277. If you refinance to a loan at 8.50, the per-lakh EMI falls to ₹1.240, and the interest to ₹48,783. If your rate difference is higher, so will be your savings.
How to refinance
You could ask your current bank to refinance your loan from an older benchmark to a repo-linked loan with a lower rate. This requires minimal paperwork and a small processing fee. Alternatively, you could transfer your loan to another bank. This comes with higher fees and greater paperwork. The all-inclusive cost should be 0.5-1% of the loan you’re refinancing. But if your rate cut is large, the refinance will pay for itself in the form of lower interest payments.
Adhil Shetty is CEO, BankBazaar.com