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PLR, Base Rate, MCLR and now RLLR—repo rate-linked lending rate: Here's what you should do for your EMI

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Home loan interest rate benchmarks have kept on changing over the last decade. We used to have the Prime Lending Rate (PLR), which was replaced by Base Rate. The base rate, in turn, was replaced by the Marginal Cost of Funds based lending rate (MCLR) a couple of years back. Now, SBI is launching a home loan product where the benchmark is linked to the Repo rate.

PLR, Base Rate, MCLR and now RLLR—repo rate-linked lending rate: Here's what you should do for your EMI
Home loan interest rate benchmarks have kept on changing over the last decade. We used to have the Prime Lending Rate (PLR), which was replaced by Base Rate. The base rate, in turn, was replaced by the Marginal Cost of Funds based lending rate (MCLR) a couple of years back. Now, SBI is launching a home loan product where the benchmark is linked to the Repo rate.
Internal Benchmark Vs. External Benchmark
Home Loans are offered at a spread over a benchmark (Benchmark + Spread). Typically, the interest rate benchmarks are internal.  This means the benchmark rate is, through a formula, linked to the cost of funds for the banks. Under the base rate regime, it was the overall cost of funds. Under the MCLR regime, it is the cost of incremental funds for the banks.
The loan spread is decided based on the quantum of loan, creditworthiness, your profession/employment status and other factors that affect your repayment ability.
With retail borrowers, a common grievance is that banks are quick to pass on interest rate hikes but are not very prompt in passing the interest rate cuts to borrowers.
By the way, retail investors are not the only ones who have issues with internal benchmarks.The Reserve Bank has its issues too. Its monetary policy transmission gets impeded. For instance, the RBI may want to boost the economy by lowering interest rates. However, if the banks do not (or cannot) cut interest rates for any reason, the repo rate cut will have no impact. Alternatively, the cut in loan interest rates may be much lesser than the policy rate cuts by the RBI. Hence, moves to linking loan interest rates to external benchmarks have been thought of. With external benchmarks, the banks cannot give any excuses. They must pass on the rate cuts/hikes in line with the change in the external benchmark.
The Reserve Bank, in late 2018, had mandated that the banks link all floating rate loans offered after April 1, 2019 to an external benchmark. Do note that the Reserve Bank has since put this direction on hold. The banks were given options for the external benchmark.
  1. Reserve Bank of India policy repo rate, or
  2. Government of India 91 days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd (FBIL), or
  3. Government of India 182 days Treasury Bill yield produced by the FBIL, or
  4. Any other benchmark market interest rate produced by the FBIL.
  5. As you can see, the Reserve Bank had not asked banks to move only to a benchmark that is linked to Repo rate. Repo rate is only one of the options. Citibank had come out with a similar home loan product in early 2018 (much before RBI guidelines). Citibank had linked the loan interest rate to 3-month Treasury bill rate. Now, when SBI comes up with a new home loan product, people notice.  It is no different this time.
    SBI Repo Rate Linked Home Loan
    From July 1, 2019, SBI shall provide an option to home loan borrowers to apply for loans with Repo rate linked lending rate (RLLR) as its benchmark.
    Repo rate linked lending rate (RLLR) is 2.25% over the Repo rate. Repo rate is the interest rate at which the Reserve Banks lends to the banks. The Repo rate is one of the monetary policy instruments used by the Reserve Bank. Currently, the repo rate is 5.75% p.a. RLLR becomes 8% p.a. An interest rate spread will be charged over RLLR.
    You will be offered home loan at:Repo Rate + 2.25% + Spread
    As I understand, RLLR is a nomenclature used by SBI to define this benchmark. Moreover, the spread of 2.25% over Repo Rate is also SBI’s choice. Other banks that link to Repo may choose a spread different than 2.25%.
    SBI Repo Rate-Linked Home Loan (RLLR): Points to Note
    1. The product is going to be launched on July 1, 2019. There is not much information on the website. Therefore, I do not yet have complete information about the loan product.
    2. You must have a minimum annual income of Rs 6 lakh.
    3. The maximum loan tenure can be 35 years (quite long).
    4. Additionally, the repayment structure is different from regular home loan products. Under regular home loan products, very little principal gets repaid initially. However, with the RLLR linked loan product, at least 3% principal must be repaid every year. Therefore, you can expect EMI (or loan installments) under this loan product to be higher. Quite possible the repayment structure is like Axis QuikPay. With a higher EMI initially, your home loan eligibility may go down (as compared to regular home loan).
    5. I do not completely understand why there is an insistence on repayment of 3% principal every year (not that it is a bad thing). Perhaps, SBI wants to control interest rate risk. After all, RLLR is an external benchmark.
    6. We do not yet know what the reset period for RLLR loan is going to be. With SBI, home loans are linked to 1-year MCLR. In such a case, the reset period is 1 year and your home loan interest rate changes only at 1-year intervals. Therefore, even though the MCLR (the benchmark) may change in the interim, the prevailing MCLR will be applicable to your loan only 1 year after the previous interest rate reset.
    7. MCLR vs RLLR: Which is better?
      The home loan borrowers will have both the options starting July 1, 2019. When MCLR was introduced to replace base rate, all the new loans were linked to MCLR. Therefore, there was no option for borrowers. Existing borrowers who had their loans linked to the base rate were given an option to shift to MCLR with or without paying the fee.
      Between RLLR and MCLR, the new borrowers have a choice. They can go with either option. Existing MCLR borrowers may get an option to switch to RLLR later with or without paying the switch fee.
      I am inclined to believe that your loan interest rate (at the beginning) will be the same.  The bank will adjust the spread accordingly. So, don’t expect quick gains because of this new variant.
      On the benefits front, if your loan is linked to an external benchmark (like Repo), you will no longer hold a grievance that your bank is not passing on the interest rate cut to you. The bank has no control over the repo rate. With MCLR, you do not know the underlying calculations. With RLLR, you know the repo rate and the spread and can calculate your loan interest rate easily.
      At the same time, repo rate can be changed by RBI at any point in time, although the announcements are typically made after bi-monthly meetings (8 weeks). Do note I still do not know what the reset period for RLLR linked home loans be. If the reset period is 3 months or 6 months, your loan interest rate and the EMI can change more frequently. As a borrower, this can be a good thing when the rates are moving down but can discomforting when the interest rates are moving up. For instance, Citibank home loan product mentioned earlier has reset period of 3 months. Currently, SBI has 1-year reset period for MCLR linked loans i.e. your loan interest rate changes only after 1 year.
      Between MCLR and RLLR, the choice is not very crisp, at least now. If you don’t trust banks, RLLR is clearly a better choice. The rest can wait and find out more details about the product before they make a choice.
       

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