Repo rate is a powerful tool used by Indian monetary authorities to control inflation and to regulate the country’s money supply, and liquidity. The current repo rate as of 22 May 2020 is 4.0%, slashed down by 40 basis points. This cutting down was made to mitigate economic risk considering the present situation.
Any change in the repo rate has a striking impact on the real estate sector. Usually, in India, home buyers use home loans to buy residential real estate. And now as millions of people are into this real sector, the link that connects repo rate and real estate sector is these homebuyers. Home loans are different from other loans due to their long tenure of about 20 -30 years. The two elements of home loan EMI are the principal amount and interest. Principal amounts are fixed whereas interest rate is variable.
The interest rate on home loans is not arbitrarily fixed by banks or housing finance companies. Before October 2019, they were linked to an internal benchmark rate, Marginal cost-based lending rates (MCLR) below which bank is not supposed to lend its customers. These rates are revised by banks from time to time. In October 2019, RBI issued a new circular stating to link home loan interest rates with a new external benchmark. The central bank provided multiple options to lenders, which includes the repo rate, the 3-month Treasury yield of the Government of India, and the 6-month Treasury yield.
Most of the lenders chose the repo rate as the benchmark for home loans. This new model was an external benchmark linked to RBI’s repo rate is called RLLR (Repo rate linked lending rate). In the case of MCLR based lending repo rates are indirectly connected to home loan rates as the marginal cost of funds included repo rate or cost of borrowing. Whereas under RLLR, rates on home loans are closely connected to repo rates. Changes made to RBI repo rates will also lead to changes in home loan rates. RLLR rates are revised every 3 months while MCLR every 6 months. Repo rate home loans are cheaper than MCLR based loans. Change in repo rate will reflect RLLR based home loans in a month or two compared to MCLR which usually takes 1 year as a base.
For all home loan takers, the principal or margin charged will be the same. As per the RBI circular, banks are allowed to charge a risk premium from borrowers. The risk premium charged will vary from one borrower to another, depending on what lenders feel risky the borrower is.
