What is MCLR and How It Affects Your Home Loan?

Posted by Bhavna Singhal on September 13th, 2018

Home loans come with an interest rate which is payable in EMIs along with the principal amount. While earlier home loans were offered at the bank’s base rate, with effect from April 2016, home loans are being offered at the bank’s MCLR. MCLR has substituted the floating rate at which home loans were earlier offered. Though the change has been implemented since 2016, many borrowers still don’t understand the concept of MCLR and its effect on home loans. So, let’s understand what MCLR is and how it impacts your home loan –

What is MCLR?

MCLR stands for Marginal Cost of funds-based Lending Rate. MCLR represents the lowest interest rate at which banks can offer a home loan. The rate is linked to the cost of borrowing for the bank. MCLR is calculated using four factors –

Marginal cost of funds – marginal cost of funds means the cost incurred by the bank on borrowing funds less the return earned by the bank on its net worth. Therefore,

Marginal cost of funds = marginal cost of borrowing – return on net worth

Cash Reserve Ratio (CRR) - CRR is the percentage of the customer’s deposits which the bank should maintain with the Reserve Bank of India (RBI) at all times. Since the bank cannot utilise the CRR, it is considered to be a cost to the bank.

Tenure premium – tenure premium is relevant in case of loans which have a longer tenure. The existing long term loans serviced by the bank are considered to determine the tenure premium

Operating costs – these costs include the costs incurred by the bank to offer the home loan

All the four factors are added together to arrive at the bank’s MCLR.

How MCLR affects home loans?

All home loans which were earlier issued on floating rates are now available on MCLR. So, if you borrow a new home loan or have borrowed a home loan after April 2016, your loan would have the MCLR interest rate. If, however, you choose or have chosen fixed rate home loans, there would be no effect of MCLR on your home loan interest rate.

Banks list multiple MCLR rates for multiple time periods like overnight rate, 1-month rate, 3-months rate, 6-months rate, 12-months rate, etc. The rates are fixed for the specified tenures. In case of home loans, 6 month or 12 month rates are used. This means that your home loan interest rate would be fixed for 6 or 12 months, as the case may be. After the tenure is over, the rate might increase or decrease.

MCLR is primarily linked to the deposit rates offered by the bank. If the deposit rates fall, there would be an immediate fall in the MCLR. Thus, MCLR allows home loan borrowers to benefit from decrease in the interest rates during the term of the loan if deposit rates decrease. Borrowers can, therefore, save money on total interest payments on home loans.

If you are looking to transfer your existing home loan, MCLR rates prove beneficial. They allow you to enjoy lower interest rates when the deposit interest rates fall. Thus, you can reduce your EMIs and save money.

You can also port your existing home loan at base rate to MCLR rates by paying a porting fee.

Floating rate home loans are now offered at MCLR rates and you have no choice but to embrace the changes. Your gain or loss from the new change would depend on the movement of the repo rate. If the repo rate falls, you would benefit from lower interest rates. So, understand MCLR, how it works and what it entails in your home loan before availing the loan.