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Tata Capital > Blog > Loan for Home > All About Switching to A Repo Linked Home Loan

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All About Switching to A Repo Linked Home Loan

All About Switching to A Repo Linked Home Loan

Understanding Repo and Reverse Repo Rates

Commercial banks borrow from the Reserve Bank of India at the Repo rate; RBI borrows from commercial banks at the Reverse repo rate. A repurchase agreement or repurchase option or repo, for short, refers to an arrangement where banks provide such securities as treasury bills or gold to borrow money from the central bank for overnight credit when the banks are short of liquidity. 

The money that commercial banks borrow from the central bank is meant to extend loans to their customers. Typically, customer deposits are also used to meet a bank’s liquidity needs. Banks borrow from the RBI at the prevailing repo rate when that is insufficient. 

Securing credit for banks is not the only function of the repurchase agreements or repos. Say, during inflation, the banking regulator or the RBI increases the repo rate. This signals to commercial banks that the RBI discourages borrowing for credit creation, which increases the supply of money or liquidity in the economy (a cause for further price rise). In the case of inflation indicators falling below a threshold, the reverse technique of reducing repo rates to encourage borrowing by commercial banks is followed. This would cause increased credit creation, which would increase the money supply and investment activity in the economy. The credit received by banks from RBI is only for an overnight duration. The securities deposited by the banks are released at a predetermined price on payback of the borrowings by the banks.

Similar liquidity needs of the RBI and their fulfilment by the commercial banks are done at the prevailing reverse repo rate. The RBI uses the reverse repo rate as an alternative method to maintain the determined inflation levels. The RBI does this by absorbing the money supply from the market at the reverse repo rate. When the reverse repo rate increases, it signals to the banks that the banking regulator wants them to lend money to the RBI, thus sucking up the credit and the liquidity in the market. The opposite happens when the RBI reduces the reverse repo rate. It signals to commercial banks that credit creation and investment activities are encouraged.

What is a Repo Rate Linked Home Loan?

The concept behind repo-linked home loans is that banks and financial institutions pass on the changes in the repo rate to the borrowers. As the bank’s borrowing cost goes down, home loans become cheaper or vice versa. For instance, during the pandemic, the RBI had brought down the repo rate to 4%, and the banks, on their part, also lowered their lending rate. Banks are quicker in passing on repo rate-related hikes in home loan interest rates to borrowers than a drop in repo rates, which causes their lending rates to drop.

Earlier, banks charged the PLR, Prime Lending Rate, but the RBI felt it wasn’t transparent enough and introduced the Base Rate concept. The Base Rate specifies a minimum rate below which the regulator forbids the banks from lending, even to their preferred clients. This provided the transparency the RBI wanted to see. It also ensured that any reduction in the repo rate would be passed on to the customers.

Benefits of Repo Linked Home Loans

Whether one is switching to a repo-linked rate or taking a new home loan, the following observations might be helpful:

  • Movements in the repo rate get factored into the EMI quicker than any rate benchmarked against banks’ internal cost of funds.
  • There is greater transparency in the rate-setting process
  • EMIs can increase if the repo rate increases.
  • Eventually, the lender or the bank settles on the final rate. The repo rate might be 4%, but the market rate for a home loan is 7%. It can fall or rise a few points based on the movement of the repo rate.
  • RBI wants all banks to adopt the linking of new loans to the repo rate, which is an external benchmark for greater transparency. The State Bank of India (SBI) has already adopted the repo-linked lending rate (RLLR) for its home loan, and so have the Bank of Baroda (BoB) and Syndicate Bank. The others are considering the switch.
  • RLLR will bring a change in the banks’ reluctance to reduce rates. According to some estimates, RLLR rates are 25-45 basis points cheaper than MCLR-linked rates (Margin Cost of Funds Lending Rate).

Steps to Switch to a Repo Rate Linked Home Loan

Switching to a repo-linked loan is about scrutinizing the costs involved:

  • Switching to RLLR within a bank is a straightforward proposition: the conversion fee paid by a borrower upfront versus the savings on interest is to be watched.
  • Switching to another institution typically happens when a borrower is unhappy with the existing institution’s rates, processing charges, valuation charges, or legal fees. More significantly, studying the spread that the other bank is charging over and above the RRLLR will be important in making the decision. Choose the bank which has the narrowest spread. That spread will mirror the RBI’s recommended rates more closely – the higher the loan’s value, the closer the fit.

Comparison: Repo Linked Home Loan vs MCLR and Base Rate Loans

A Repo Linked Home Loan is directly tied to the RBI’s repo rate, making it more transparent and responsive to policy changes. Under the repo-linked lending rate, any cut or hike in the repo rate is passed on to borrowers faster. Hence the repo rate impact on home loan EMIs is clearly visible.

In contrast, MCLR and Base Rate loans depend on banks’ internal benchmarks, which adjust slowly and reduce the immediate benefit of rate cuts. Base Rate loans are the least transparent, while MCLR offers limited clarity.

Because repo-linked loans adjust faster, they are generally more transparent and borrower-friendly than MCLR and Base Rate loans.

Common Charges and Hidden Costs in Switching Repo Linked Loans

Switching to repo-linked home loan often involves a one-time conversion fee charged by the lender. This fee may be a fixed amount or a small percentage of the outstanding loan balance. It is meant to cover administrative work and discourage frequent changes between different home loan interest rate benchmarks.

Before approving the switch, lenders may reassess repo rate home loan eligibility. They often review the repayment history and remaining tenure, and not the income or credit score again. In some cases, the loan tenure or EMI structure may be adjusted to align with the new benchmark-linked rate.

Despite these costs, switching can still be beneficial in the long run. Repo-linked loans reflect rate cuts faster, which can reduce overall interest costs. Borrowers should do a cost-benefit analysis to ensure that the savings from lower interest rates outweigh the conversion charges involved.

Conclusion 

A word of caution. Let’s assume that the discussions have started with a bank, and the borrower feels that the initial rate looks attractively low. However, the factors that increase the interest rate, namely the loan-to-value ratio, the borrower’s credit score, and the number of other house properties the borrowers own (two or more), could quickly increase the rate. It is therefore suggested that the difference between the bank’s RLLR and the net interest rate should be watched carefully before deciding on the switch. If you are short of funds, avail of a Home Loan from Tata Capital.

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FAQs

What is a repo rate linked home loan?

A repo linked home loan is a housing loan where the interest rate is directly tied to the RBI’s repo rate. When the repo rate changes, the loan interest adjusts accordingly, usually at regular intervals, making rate movements more transparent for borrowers.

How is repo rate linked home loan different from MCLR linked loan?

 

A repo rate linked home loan responds faster to RBI rate changes, as it is externally benchmarked. MCLR-linked loans depend on internal benchmarks set by lenders, which may delay rate transmission, meaning borrowers feel the impact of rate cuts much later.

What are the benefits of switching to a repo linked home loan?

 

Switching to a repo linked home loan can lead to quicker interest rate reductions when the repo rate falls. It offers better transparency, potentially lower interest costs over time, and clearer understanding of how policy rate changes affect your loan.

How does the repo rate affect my home loan EMI?

 

When the RBI reduces the repo rate, the interest on a repo-linked loan usually falls, lowering your EMI or loan tenure. If the repo rate rises, EMIs may increase. The key advantage is faster and clearer transmission of rate changes.

Are there any costs in switching to a repo linked home loan?

 

Yes, lenders may charge a small conversion or administrative fee when you switch. There could also be minor documentation costs. These charges are usually one-time and often outweighed by long-term interest savings.

Can I switch back if I’m unhappy with the new loan terms?

 

Lenders generally allow borrowers to change loan benchmarks again, subject to their policies and applicable fees. However, you must read the loan agreement carefully and understand the flexibility offered before switching.

Which banks offer repo rate linked home loans?

 

Most major housing finance lenders and large lending institutions in India now offer repo rate linked home loans. Availability, spreads, and reset periods may vary, so it is best to compare options across lenders before making a decision.

How often do repo rates change?

 

The repo rate usually changes during the RBI’s monetary policy reviews, which are held six times a year, roughly every two months.

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