Want to be debt-free? Know your MCLR!

Refinance or prepay your loan by understanding how MCLR affects your EMIs.

Want to be debt-free? Know your MCLR!

Lending rate revisions receive a lot of interest from the media and consumers, and with good reason. After all, they play a role in determining what amount you would need to shell out in terms of loan EMIs and how much you stand to make in terms of return on investments. 

It is worth spending some time to understand the dynamics of interest rate fluctuations, given its implications for your financial fortunes. Before you can weigh the pros and cons of a balance transfer on an existing loan or prepaying part of it, you must familiarise yourself with the intricacies of the Marginal Cost of Funds Lending Rate (MCLR).

What is MCLR?

To figure out how MCLR works, it is important to understand base rate and repo rate. Base rate is the minimum rate of interest at which banks are authorised to lend money. Repo rate, on the other hand, is the rate at which banks borrow funds from the RBI. These two factors influence the rate of interest charged by banks in order to earn a profit.

MCLR was introduced by the Reserve Bank of India (RBI) in April 2016. It replaced base rate as the criterion for calculating interesting rates. Simply put, MCLR refers to the base rate plus the margin at which banks lend to borrowers.

Interest paid by banks remains fixed until the maturity of the deposits they hold. Earlier, when the RBI cut interest rates, lending costs for banks did not change immediately. This made it difficult for banks to pass on the benefits of the rate cut to the end consumer. 

To rectify this situation, the RBI brought in MCLR. It takes into account four major factors: marginal cost of funds, negative carry on CRR (cash reserve ratio), operating costs, and tenor premium. Let’s look at each of them in detail.

Related: How RBI rate cut will impact borrowers and investors?

Components of MCLR

  • Marginal cost: This is essentially the cost incurred by a bank to mobilise savings from its depositors in terms of interest paid; it also includes interest paid to the RBI on borrowed funds (repo rate).
  • Negative carry on CRR: Banks are required to maintain cash reserves with the RBI that do not accrue interest. These have zero returns for the bank.
  • Operating costs: Overheads such as manpower, infrastructure, and technology incurred during the course of operations are also factored in as input expenses.
  • Tenor premium: Banks have been asked to publish MCLR rates for five different tenures, ranging from less than 24 hours to long-term ones spanning a year.

What does MCLR do for you?

MCLR makes interest rates far more transparent. As banks get more competitive, they offer customers a wider range of loan options to choose from. This allows the RBI to ensure that the benefits of lower interest rate trickle down to the consumers. 

MCLR changes on a monthly basis. This means that loan EMIs stay well within control, much to the relief of the average borrower. 

Related: P2P: A new lending and borrowing option to explore

How does MCLR work?

The RBI requires banks to offer five MCLR slabs: overnight, one day, 3 months, 6 months and 1 year. For home loans, MCLR is usually calculated on a half-yearly or yearly basis. It is revised when the repo rate changes on a biannual or annual basis. MCLR is also influenced by one’s individual credit score and risk assessment performed by the bank.

Since it is not feasible for banks and NBFCs to provide loans at cost, MCLR includes an additional markup component. It varies across banks based on the asset type, customer risk profile, repo rate etc. 

Impact of MCLR offered by various banks

The RBI has cut interest rates five times so far since April 2019. This has had a positive effect on loan EMIs for both new and existing borrowers. 

If you’re a woman buying a home for the first time, you can avail of lower interest rates offered by banks under Pradhan Mantri Awas Yojana (PMAY).This incentive is designed to encourage home ownership by women in both urban and semi-urban areas. 

The difference in terms of interest rates on loans for men and women is 0.05% on average. Here’s a look at the interest rates offered by some leading banks:

1. State Bank of India:

SBI cuts its 3-year MCLR interest rates to 8.20% for salaried and self-employed categories and it slashed 1-year rates to 7.90%. Six month rates stand at 7.85%. This is expected to bring cheer to home loan borrowers with attractive floating rates. The revised rates took effect on January 10, 2020. If your annual MCLR reset date is for a future date, you can avail of the benefit of the slashed cut immediately. For others, it will be a while longer before they will see some savings in terms of monthly outgo. 

2. HDFC Bank:

Like SBI, HDFC Bank too has announced that it will reduce MCLR rates by 15 basis points, effective from December 7, 2019. Compared to 8.5% in November last year, the bank has revised its rates downwards to 8.35% for tenures of up to 3 years. The base rate has been cut from 9.2% to 8.85% now; consequently 1 year MCLR has been pegged at 8.15%, down from 8.3% in November. Rates for tenures of up to 6 months have been dropped marginally to 8%. For January 2020, rates remain the same. 

The recent spate of rate cuts means that consumers will be able to save more to meet their financial goals.

3. ICICI Bank:

For its part, ICICI Bank has slashed MCLR to 8.20% for 1 year, 8.15% for 6 months and 8% for 3 months respectively, as of January 2020. Benchmark rates for ICICI stood at 8.85%. 

MCLR can help you keep your monthly budget from spiralling out of control as EMIs become more flexible.

Last words

MCLR makes loan EMIs more predictable for consumers, enabling them to negotiate better when considering a balance transfer or prepayment. With an array of tax benefits and interest waivers, borrowers can avail of better returns on investment over the long term. 

Read this piece to know how to borrow money and benefit from it?


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