Buying a house is one of the most significant financial decisions of your life. Hence, it is essential for you to be aware of its various aspects. Whether you want to buy a ready-to-move apartment or build a house from scratch, you would most likely be considering taking a home loan.
Lenders offer several easy home loans as long as you meet the eligibility criteria. While the loans may seem identical at first glance, the real cost of your home loan depends on several factors like the amount of money you borrow and the loan tenure.
However, the rate of interest the bank charges on your loan impacts your EMI most significantly. Have you ever wondered what determines the value of the home loan interest rates that you are charged by the lender that grants you the loan?
The most critical factor that influences the rate of interest is the repo rate.
Before diving into how it is linked to the monthly EMIs of your housing loan, here is a brief introduction to the repo rate. In simple words, it is the rate of interest at which the central bank, the Reserve Bank of India lends money to commercial banks.
Here’s how it usually works.
During a period of inflation, the Reserve Bank of India generally raises the repo rate. It is done to discourage commercial banks from borrowing money, thereby reducing the supply of money in the economy.
Conversely, when the inflation rate falls or during a period of recession, the Reserve Bank of India decreases the repo rate. It acts as an incentive for commercial banks to borrow more money. In turn, it makes more funds available to their customers, thereby increasing the supply of money in the system.
To fight the recession caused by COVID-19, the central bank has currently slashed its repo rate to an all-time low of 4.40%.
Additional Read: RBI Cuts Repo Rate by 75 bps to 4.40% to Fight Covid-19
However, it has been observed that when the Reserve Bank of India reduces its rates, other banks take a while before decreasing the lending rates to customers. On the other hand, banks are quick to raise their lending rates when the repo rates go up. Therefore, the RBI incorporated the Marginal Cost of Funds based Lending Rate regime in April 2016 to alter the way commercial banks function.
The MCLR is an internal reference for commercial banks to decide the rate of interest they can charge on loans. As part of this regime, banks have to adjust their interest rates as soon as there is a change in the repo rate. The implementation of this regime improves the transparency in the system followed by banks to compute the rate of interest on advances.
For more queries about factors affecting home loan interest rates, visit the Tata Capital website.
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Additional Read:- RBI’s Moratorium on EMI Payments during Covid-19