Home Loan: A Note on Switch from MCLR to RLLR

The Marginal Cost of Fund-based Lending Rate (MCLR) is known to directly impact home loan Equated Monthly Installments (EMIs). 

Essentially, MCLR is the minimum interest rate that a particular financial institution needs to charge for a specific loan. It is the internal benchmark rate that determines the interest rate for the loans given by banks. 

Introduced by the Reserve Bank of India (RBI) in 2016, MCLR is a modification to the old base rate system. This introduction was undertaken with the intention of passing on the benefits of rate cuts to a borrower. However, this switch did not prove to be of much benefit to borrowers.

That is exactly the reason why the RBI in 2018 directed banks to switch to an external lending benchmark so that the borrowers could get the benefits of changes in the monetary policy. 

This led to the introduction of Repo Linked Lending Rate (RLLR) home loans, which ensured a faster transition in loan rates. Under this, borrowers could get a lot of flexibility in their loan rates. Also, these loans are said to have a more transparent rate-setting mechanism and provide more certainty to a borrower in anticipating the loan interest rates.

So, what led to the rise in MCLR rates? When the RBI increased the repo rate—the rate at which the banks borrow from the central bank—most banks were slow to raise the MCLR. 

As of March 31, 2023, the interest rate on home loan rates based on the one-year MCLR regime went up by 135 basis points (bps) or 1.35% as compared to the home loans linked to the External Benchmark-based Lending Rate (EBLR), which is linked to the repo rate.

As a result, the home loans linked to the EBLR or repo rate had a rate hike of 250 bps or 2.50%. That meant borrowers who had their MCLR reset in October or December were paying much lower interest rates as compared to those with EBLR-linked home loans.

However, as the repo rate hikes have stopped, the banks adjust the MCLR rates to the new circumstances.

To cite an example, consider an individual who has a home loan of Rs 20 lakh with a tenure of 10 years and an MCLR-linked interest rate of 6%, and the current EMI is Rs 20,000.

Now, if the MCLR rate rises by 25 bps or 0.25%, the new effective interest rate would be 6.25%, and the new EMI would be Rs 20,250. This means that the monthly EMI will witness a spike of Rs 250 due to the interest rate hike. This highlights that the increase in the MCLR rate will have an influence on home loans. 

In this, should an individual make the switch to RLLR home loans? It is important to note that RLLRs are more transparent than MCLRs. Moreover, they have a faster transmission on their loan rates. 

However, if the RBI decides to increase the rates in quick succession considering the market conditions, EMIs also tend to rise quickly in proportion to the repo rate.

So, before switching to RLLR, an individual must ideally compare the prevailing interest rate with MCLR, the rate linked to the external benchmark and the reset frequency. 

Ideally, do a calculation and take the decision only when sure that the savings are higher than the refinancing cost. However, once an individual opts for the RLLR, switching to another benchmark rate won’t be possible.

Also, if an individual decides to do refinancing with a new lender, then the loan will be considered a fresh application. An individual will be required to go through the entire home loan approval process once again.

After considering all this, if an individual still wishes to transfer a home loan from the MCLR regime to an RLLR with the same bank, all they are required to do is to approach the bank and submit an application in this regard. 

Also, take note to negotiate interest rates if the credit score has improved in the last one year.