Your home loan EMIs are now linked with repo rates

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A repo rate is a monetary tool applied by the Reserve Bank of India to regulate the supply of money or to maintain liquidity in the economy. In May, the central bank lessened the repo rate by 40 basis points to 4%. The cut was followed by a 75 basis-point reduction in March.

A variation in the repo rate has a profound influence on the real estate segment. The millions of buyers across India are the essential link between the repo rate and the real estate segment. Homebuyers in India usually take a home loan to purchase residential real estate. Home loans are different from other loans like car loans and other retail loans, essentially due to the term of the loan. Home loans are a long-term responsibility and usually last for about 20-25 years. There are two elements of a home loan EMI—principal amount and interest. The principal amount is fixed, but the interest rate differs. Even small changes in the interest rate followed by a raise either in the monthly EMI or the overall tenure of the loan.

The interest rate on home loans is not determined arbitrarily by banks or housing finance companies. Home loan interest rates are associated with an external benchmark. Prior to October 2019, lenders used Marginal Cost-based Lending Rates (MCLR) as the benchmark for home loans. In October 2019, the RBI published a notice that steered banks to provide home loans linked to new external benchmarks. The RBI gave various prospects to lenders, which covered the repo rate, the 3-month Treasury yield of the Government of India, and the 6-month Treasury yield.

A majority of lenders opted for the repo rate as the external benchmark for home loans, which is known as the Repo Rate Linked Lending Rate (RLLR). In MCLR-based lending, the repo rate indirectly influenced home loan interest rates as the marginal cost of funds covered the repo rate or the cost of borrowing. However, an adequate RLLR interest rate depends on many factors. For instance, the RLLR-linked home loan interest rate will depend on several factors such as what the loan amount is, the loan-to-value of the loan, and even the risk group of the borrower, amongst other things.
The margin imposed by a bank will remain equal for all home loan takers. But, according to RBI notification, banks are permitted to charge a risk premium from borrowers. Risk premium charged by the bank will depend on how risky your bank regards you to be and will, hence, vary from one borrower to another.

The interest rate on home loans consists of the RLLR, the margin, and the risk premium. The risk premium fluctuates, but the margin is identical for all the borrowers. Considering that home loan interest rates are associated with the repo rate, banks have to review the interest rate at least once in three months.

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