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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. <\/p>\n\n\n\n
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\u2019s liquidity needs. Banks borrow from the RBI at the prevailing repo rate when that is insufficient. <\/p>\n\n\n\n
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.<\/p>\n\n\n\n
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.<\/p>\n\n\n\n
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\u2019s borrowing cost goes down, home loans<\/a> 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<\/a> to borrowers than a drop in repo rates, which causes their lending rates to drop.<\/p>\n\n\n\n Earlier, banks charged the PLR, Prime Lending Rate<\/a>, but the RBI felt it wasn\u2019t 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.<\/p>\n\n\n\n Whether one is switching to a repo-linked rate or taking a new home loan, the following observations might be helpful:<\/p>\n\n\n\n Switching to a repo-linked loan is about scrutinizing the costs involved:<\/p>\n\n\n\n A Repo Linked Home Loan is directly tied to the RBI\u2019s 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<\/a> is clearly visible.<\/p>\n\n\n\n In contrast, MCLR and Base Rate loans depend on banks\u2019 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.<\/p>\n\n\n\n Because repo-linked loans adjust faster, they are generally more transparent and borrower-friendly than MCLR and Base Rate loans.<\/p>\n\n\n\n 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.<\/p>\n\n\n\n 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.<\/p>\n\n\n\n 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.<\/p>\n\n\n\n A word of caution. Let\u2019s 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\u2019s 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\u2019s 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<\/a>.<\/p>\n\n\n\nBenefits of Repo Linked Home Loans<\/strong><\/h2>\n\n\n\n
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Steps to Switch to a Repo Rate Linked Home Loan<\/strong><\/h2>\n\n\n\n
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Comparison: Repo Linked Home Loan vs MCLR and Base Rate Loans<\/strong><\/h2>\n\n\n\n
Common Charges and Hidden Costs in Switching Repo Linked Loans<\/strong><\/h2>\n\n\n\n
Conclusion <\/h2>\n\n\n\n