MCLR Demystified

Until last year, banks used to fix their lending rates according to their Prime Lending Rates (PLR's), but now they're mandated to link their lending rates to their MCLR (Marginal Cost Based Lending Rate) figures instead. A Bank's MCLR is derived from four components - namely: marginal cost of funds, negative carry on account of cash reserve ratio (CRR), tenor premium, and operating costs.

The move to peg lending rates to the MCLR has led to higher transparency in loan pricing, as well as a quicker transmission of rate changes to end users. Banks revise and publish their MCLR numbers on a monthly basis, but the changes, if any, are passed through to your loan either once in six months or once in twelve, depending upon the reset period chosen by you. Effectively, an MCRL linked home loan acts as a "fixed rate" loan for either 6 or 12 months.

Rates could fall further
Home Loan rates have been falling steadily in the past twelve months, with the competition between lenders intensifying. A number of lenders chose to further reduce their home loan rates in May this year, despite RBI not offering any further elbow room in the form of a rate cut, for the past several policy meets. With inflation reined in for now, the market is anticipating a reduction in the repo rate in October. Were that to happen, we're likely to see rates dropping even further, bringing cheer to borrowers.

Should you rush in to take a loan and buy a home?
Whether or not this is a good time to go for a home loan right now really depends upon the homebuyer's objective, more than anything else. If you're looking to invest to earn returns and flip the property in a few years, this is most likely not a good time for most metro locations, which are still reeling from unsold inventory and therefore having limited scope for medium term price appreciation. Remember that home loans front end much of the interest, and so the equity you'll be building up in your property in the first half of the loan period will actually be quite insignificant.

If you're looking to buy as an end user, purchasing a property merely because it's "within your budget" may lead to the all too common "homebuyers regret" phenomenon soon after. Make sure you check off critical aspects such as infrastructure, safety & crime rates, connectivity, resultant increase in your work commute, and proximity to schools and creches before you sign up. To take advantage of falling rates, those who avail home loans may like to opt for the 6-month MCLR reset period option over the 12-month one. This will ensure that the impact of falling rates is passed on to them quicker, leading to interest savings.

12 month or 6 month reset?
A key question in the minds of new borrowers is - should you opt for a 12 month or a 6 month MCLR reset period right now? In scenarios such as todays, where rates are projected to come down in the medium term, it certainly makes sense to select a shorter reset period so that the benefits of the reduced rates get passed on to you more quickly. However, the long-term nature of home loans will most likely act as a great leveller, as there would be rising rate cycles when the shorter reset period would work against you. A grey area still exists on whether or not banks are flexible on changing reset periods back from 6 months to 12 months, and vice versa - borrowers would do well to clarify this point carefully with their lender of choice. Additionally, one must factor in rate differentials between the two reset period options, if any. If rates for both options are the same, and if your bank provides you with the option to switch your reset period as required during the tenor of your loan, it would be wise to opt for the 6-month reset period in the present scenario.