Home Loan

How to Reduce Existing Home Loan Interest Rates

Banks and housing finance companies reduced interest rates on home loans. Banks charge a conversion fee of around 0.5% on your outstanding loan amount, plus taxes. For instance, if your home loan outstanding is Rs 10 lakh, the conversion fee would be around Rs 5,000, plus taxes.

1. Banks follows MCLR (Marginal Cost of fund-based Lending Rate) model

The MCLR is the benchmark rate below which a bank cannot lend and is calculated based on a prescribed formula based of four variables (1) marginal cost of funds (2) operating cost (3) tenure premium and (4) negative CRR-carry cost.

MCLR replaced the earlier Base Rate System, which, in turn, had replaced the PLR in banks. The objective of these shifts by the regulator (RBI) has been to move to a more transparent  and market-determined rates.

Thus MCLR is a more dynamic model reflecting the incremental cost of funds and changes on a monthly basis. All new home loans taken from a bank with effect from April 2016 are on MCLR.

Due to the formula system of MCLR, SBI had to cut its MCLR from January 1, 2017, from 8.9% to 8%. SBI did not pass on this entire reduction of 90 bps to customers. Concurrently, it increased the margin on top of MCLR. Thus new home loan rates fell by around 50 bps and now will be in the range of 8.6%-9.1% depending on the ticket size and type of loan.

Being on an MCLR system provides home-loan customers with a more dynamic interest rate environment and is beneficial to customers. When one takes a home loan linked to MCLR, one should remember that the interest rate changes only on a pre-determined reset date. Between two reset dates, an MCLR home loan works like a fixed rate loan oblivious to any changes in the MCLR. RBI allows banks to have a reset period up to a maximum of one year.

For example, SBI has a reset period of one year, whereas HSBC has a reset period of 3 months. Thus a home loan customer who had taken a loan from SBI in Dec 2016 say at 9.3%, will not have any benefit of the current reduction in interest rates till December 2017, but new customers will be eligible for lower rates. Ideally one should choose a lower reset period to have a truly floating home loan

 2. Housing-Finance Companies (HFCs) continue on the PLR (Prime-Lending Rate) model.

Home loans prior April 2016 would be on base rate or the PLR, which will be slower to react to changes in the interest rates. Home loans from HFCs like HDFC still work on the PLR model.

What happens if you are on base rate or PLR model. Either you should move over to the MCLR model (which is a mandated option you have, though your bank may charge you for it) or wait for the base rate/PLR to come down

 If you are with an HFC like HDFC, you could negotiate with your home-loan provider to shift your interest rates down to the prevailing market rates or shift over to a bank on the MCLR system. Every day of delay costs you money lost in higher interest

Most importantly, switching to MCLR is a one-time option, you cannot revert to base rate again. And once you choose an MCLR rate, you cannot reset it for the next one year.

The MCLR system doesn’t apply to housing finance companies (HFCs) and non-banking financial companies (NBFCs). So, if you have taken a loan from either, you can reset your interest rate by paying a conversion fee.

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