How RBI rate cut will impact borrowers and investors?

Have a look at the impact of repo rate on different kinds of borrowers

How RBI rate cut will impact borrowers and investors?

On August 7, Wednesday, Reserve Bank of India announced the fourth rate cut of this calendar year. It reduced the repo and the reverse repo rate by 35 basis points (bps). The repo rate now stands at 5.40% and reverse repo rate at 5.15%. This has been done to infuse some liquidity into the economy by encouraging borrowing at reduced interest rates.

What is repo rate? 

In simple words, repo rate is the rate at which the central bank of a country (RBI in the case of India) lends money to commercial banks in case there is a shortfall of funds. Authorities use repo rate to control inflation.

What is a basis point?

One basis point is equivalent to 1/100th of 1% or 0.01%. Therefore if the repo rate was 5.2% earlier and increased by 35 basis points, then it would mean that repo rate is now 5.2%+0.35% = 5.55%

Basis point is usually used to denote interest rate changes in financial instruments.

What is the weighted average interest rate?

The aggregate rate of interest paid on all debt is called the weighted average interest rate. For example, if an individual has taken a housing loan of Rs 20,00,000 from a bank at 10% interest and a vehicle loan of Rs 2,00,000 at 12% interest, then weighted average interest rate is calculated as follows:

(Rs 2,00,000 [interest on home loan]+ Rs 24,000 [interest on vehicle loan])/(Rs 20,00,000+Rs 2,00,000)

= Rs 2,24,000/Rs 22,00,000 = 10%

Related :  How interest rates impact mutual funds

What is MCLR?

It is the minimum rate below which a bank cannot lend. It stands for Marginal Cost of Funds based Lending Rate. It is an internal benchmark rate for a bank.

What is BPLR?

It is the rate at which commercial banks charge their most creditworthy customers. It stands for Benchmark Prime Lending Rate.

Impact on Fixed income returns

As key rates are reduced, the interest rates that banks can provide on fixed income instruments like fixed deposits (FDs) are also restricted. SBI recently announced a 50-75 bps interest rate cut on FDs with tenure up to 179 days. The impact on FDs of longer tenure was shallower, and the bank cut the interest rate by about 20 bps. The interest rate on small savings scheme has also been reduced by 10 bps for the July-September quarter during the quarterly review.

Impact on Home loans

The fourth-rate cut should bring cheer to the borrowers as their EMIs are likely to go down if the banks pass on the benefit of the rate cut to its borrowers. The government hopes that this would kickstart the credit flow in the affordable housing sector giving a boost to the economy.

RBI's policy statement stated that the repo rate cuts have been transmitted to the weighted average lending rate (WALR) on fresh rupee loans. The WALR has been reduced by 29 bps since the first-rate cut in February. It is expected to be reduced further as a result of continuing policy rate cuts.

A reduction of 35 bps translates into, roughly, Rs 661 reduction on the EMI for Rs 30 lakh with a tenure of 20 years. Let us look at how the rate cut is expected to impact different borrowers:

Existing borrowers with loans linked to MCLR

Following the June Monetary Policy Review, SBI has cut its marginal cost of funds based lending rate (MLCR) by 5bps. Other banks are expected to follow suit, but the quantum and timing of the cut will vary from bank to bank. The reduction in MCLR will result in the EMIs going down, starting the reset date of your home loan. The reset date for most home loans is either every six months or every year and would be mentioned in your loan documents.

Related: Home Loans Set For Floating Interest Rate Revamp from April 2019 

Existing borrowers with loans linked to BPLR

SBI has not announced any further reduction in the base rate or the benchmark prime lending rate (BPLR) since March 2019. The transmission on policy rate cuts to BPLR is usually lower than the transmission to MCLR. If your loan is linked to BPLR, you should consider switching to an MCLR-linked loan. As per RBI guidelines, interest rates on all loans offered on or after April 1, 2016, must be linked to MCLR. The loans older than this can be linked to either. If your loan is still linked to BPLR, you could switch to MCLR linked loan with the same bank or refinance your loan from another bank.

Related: What is Loan Against Property?

What can new borrowers do?

New borrowers can take a home loan with interest rate linked either to MCLR or directly to the repo rate. Currently, SBI is the only lender offering home loans with interest rates linked directly to the repo rate through a fixed formula. Further, check if any subsidy is available to you when taking on a new home loan. For example, households with income between Rs 6 lakh to Rs 12 lakh get an interest subsidy of 4% and with income between Rs 12 lakh and Rs 18 lakh of 3% under Pradhan Mantri Awas Yojna. This subsidy is available until March 31, 2020, at the moment.

Have a look at how most of the interest incomes are taxed to understand the nuances involved behind the taxation process.

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