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Base Rate vs MCLR: Key Differences & Impact on Loan Rates

Base Rate vs MCLR: Key Differences & Impact on Loan Rates

A home is a safe space where you can relax without worry. Today, owning a house is a dream most people have, but applying for a home loan can often be confusing. Especially because of different loan rates and terms, comparing and contrasting takes time.

To make your job easier, in this article we aim to explain everything there is to know about MCLR and base rates so you can make an informed choice.

What is Base Rate?

The Base Rate was introduced in July 2011. It is the minimum interest rate at which a bank can lend money, with some exceptions dictated by the RBI. 

It is determined by the given factors:

– Average Cost of Funds: Interest rate provided by bank on deposits.

– Operating Cost: The cost of day to day expenditure of banks.

– Negative Carry in Cash Reserve Ratio: The cost incurred by the banks to keep a specific amount of funds with the RBI.

The Base Rate system was introduced to bring uniformity and transparency in lending rates and to prevent lenders from offering loans at arbitrarily low rates. Under this system, lenders calculated lending rates based on historical averages rather than current market conditions. 

As a result, changes in RBI policy rates were not immediately passed on to borrowers. This often meant that even when interest rates fell, existing borrowers continued to pay higher EMIs for longer periods. Over time, this limitation led to the need for a more dynamic benchmark system.

What is MCLR?

The Marginal Cost of Fund-based Lending Rate (MCLR) for a home loan is the minimum interest rate a bank must charge for lending. It was introduced by the Central Bank of India and came into effect on April 1, 2016.

Since then, it has functioned as the internal benchmark followed by banks while giving out loans in any category. It replaced the Base Rate system which had been in place since 2010.

The MCLR framework was designed to improve the transmission of RBI policy rate changes to borrowers. Unlike the Base Rate, MCLR is based on the current cost of funds, making it more sensitive to changes in the repo rate. 

Lenders publish different MCLR rates for various tenors, such as overnight, six months, and one year. Most home loans are linked to the one-year MCLR, which is revised periodically, allowing interest rates to adjust more efficiently with market conditions.

The MCLR rate follows a tenor-based methodology, meaning it can be changed depending on the period left before the loan repayment becomes due. 

It is determined by the following factors:

1. Marginal Cost of Funds: It is the incremental cost of borrowing more money along with return on net worth. The former has a 92% influence while the latter has 8%. It also includes the repo rate.

2. Negative Carry on Account of CRR: The Cash Reserve Ratio is the minimum amount of cash reserve that a bank must maintain in the Reserve Bank of India (RBI) at all times. This cash deposit has to be taken under consideration while determining the home loan interest rate.

3. Operations Cost: This involves the operational costs of the bank’s daily activities.

4. Tenor Premium: It is the premium charged based on the period of the loan.

Essentially, the MCLR offers a floating interest rate, subject to fluctuation if there are changes in the Repo rate. Generally, MCLR interest on home loans is lower than the Base Rate.

The key difference between the two is that the Base Rate on loans is determined by the average cost of funds while MCLR is determined by the current cost of funds.

Base Rate vs MCLR: 5 Key Differences Explained

Base Rate and MCLR are both lending benchmarks used by lenders to price home loans, but they differ in how interest rates are calculated and passed on to borrowers. 

Here’s how they differ: 

1. Method of Calculation

Base Rate is calculated using the lender’s average cost of funds, which is based on past borrowing and deposit costs. MCLR is calculated using the current or marginal cost of funds, making it more reflective of present market conditions.

2. Response to RBI Rate Changes

Base Rate responds slowly to RBI policy changes because it relies on historical averages. MCLR responds faster since it includes the repo rate directly in its calculation.

3. Tenor-Based Pricing

Base Rate is a single rate applied across loans. MCLR varies by loan tenor, such as overnight, six months, or one year, allowing lenders to price loans more precisely.

4. Interest Rate Transparency

MCLR offers greater transparency, as lenders must disclose how rates are derived. Base Rate provides less clarity on how rate changes are passed on.

5. Impact on Your EMI

If your loan is linked to MCLR, you are likely to benefit sooner from interest rate cuts, while Base Rate-linked loans may take longer to reflect changes.

How to Check Current Base Rate & MCLR for Your Loan

Knowing whether your loan is linked to the Base Rate or MCLR, and what the current rate is, helps you understand why your EMI changes and whether switching benchmarks makes sense. 

Here’s how to check it: 

1. Check your loan agreement or statement: Your sanction letter or latest loan statement clearly mentions whether your loan is Base Rate–linked or MCLR-linked.

2. Visit your lender’s official website: Lenders publish their latest Base Rate and MCLR values in the interest rates or regulatory disclosure section.

3. Identify the applicable tenor: If your loan is MCLR-linked, check the relevant tenor, usually the one-year MCLR for home loans.
4. Compare with your charged rate: Match the published rate with the rate applied to your loan, including the spread.

5. Contact customer support if needed: If details are unclear, your lender can confirm the benchmark and reset cycle.

How Base Rate & MCLR Impact Your Loan EMIs

The benchmark linked to your loan determines how quickly interest rate changes affect your monthly EMIs.

1. Speed of EMI change: MCLR-linked loans reflect interest rate changes faster, while Base Rate–linked loans adjust more slowly.

2. Response to rate cuts: When RBI reduces rates, MCLR loans usually benefit earlier, potentially lowering EMIs sooner.

3. Stability vs flexibility: Base Rate loans offer more stability but slower relief. MCLR loans are more flexible but can change more frequently.

4. Overall interest cost: Faster rate transmission under MCLR can reduce total interest paid over the loan tenure.

5. Reset frequency: MCLR loans reset at fixed intervals, while Base Rate revisions may not follow a predictable cycle.

Is MCLR Better Than Base Rate? Key Considerations

Whether MCLR is better than Base Rate depends on your loan stage, financial planning style, and interest rate environment. In most cases, MCLR offers more transparency and faster alignment with market conditions, which works in favour of borrowers during falling rate cycles.

Here are some things you should consider: 

– MCLR reflects current borrowing costs and includes the repo rate, making it more responsive.

– You benefit sooner from rate cuts compared to Base Rate-linked loans.

– EMIs under MCLR may fluctuate more often, requiring better budgeting.

– Base Rate loans change slowly, which can delay benefits but add predictability.

– Switching from Base Rate to MCLR may be beneficial if the spread and reset terms are favourable.

Conclusion

Understanding the difference between Base Rate and MCLR helps you see how your home loan interest rate is set and how quickly it responds to changes in RBI policy. While Base Rate offers stability, MCLR provides better alignment with current market conditions, allowing interest rate changes to reach borrowers faster.

Before choosing or switching your loan benchmark, it helps to review your repayment goals, budget comfort, and interest rate outlook. A clear understanding of how these benchmarks work allows you to plan EMIs more confidently over the long term.If you are planning to take a home loan or considering refinancing, Tata Capital offers home loans with transparent terms and competitive interest rates. Our expert guidance and tools such as a home loan EMI calculator will help you choose the best loan plan for your dream home. Visit our website to learn more.

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FAQs

What is the meaning of MCLR in loans?

MCLR means Marginal Cost of Funds-based Lending Rate, the minimum interest rate banks charge on loans, calculated using current borrowing costs, repo rate, operating expenses, and tenor premium components today.

How does MCLR affect my home loan EMI?

MCLR affects your home loan EMI by changing interest rates at reset intervals, so when rates fall EMIs may reduce, and when rates rise your EMI can increase accordingly periodically.

Is MCLR always lower than Base Rate?

MCLR is generally lower than Base Rate because it reflects current funding costs, but it is not always lower, as rates depend on market conditions and bank-specific spreads and policies.

What is the tenure premium in MCLR?

Tenure premium in MCLR is the additional interest charged based on loan duration, where longer tenures carry higher risk and therefore attract a slightly higher interest rate for borrowers overall.

How do banks calculate Base Rate?

Banks calculate Base Rate using the average cost of funds, operating expenses, and the cost of maintaining cash reserves with the RBI, rather than current market borrowing rates for lending.

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