A home loan EMI comprises of two parts – principal and interest. The principal amount of an EMI remains constant, but the interest is variable. Ever wonder why a change in the external benchmark say RBI repo rate reflects in the interest outgo and subsequently, in the home loan EMI payments? Read on to find out the answer.
How Are Home Loan Interest Rates Decided?
In 2019, RBI mandated lenders to link their floating home loan interest rates to an external benchmark rate instead of Marginal Cost-Based Lending Rate (MCLR). There are three types of external benchmark rates –
- Policy repo rate of RBI
- Certificate of deposit rate
- Treasury bill rate
Under the MCLR regime – that preceded the external benchmark regime – lenders followed internal benchmark rate to lend a home loan in India. As a result, the benefits of the policy rate cuts by RBI did not reach the end-users on time.
However, under the external benchmark regime, key interest rate cuts by RBI are transmitted to the end-users immediately. Lenders can charge any spread (margin and premium risk based on the applicant’s credit profile) over and above the external benchmark rate.
Therefore, if your lender has adopted the repo rate as the external benchmark for a home loan online or offline, any change in RBI’s repo rate will reflect in your home loan EMIs.
What Is Repo Rate?
A repo rate is a rate at which lenders borrow money from RBI (the central bank of India) in case of a shortage of funds. It is a monetary policy that is used to control Inflation, money supply, and liquidity in the Indian economy.
The lending interest rate, which is linked to RBI’s repo rate, is known as Repo Rate Linked Lending Rate (RLLR). For an RLLR-linked home loan, the interest is calculated like this:
- RLLR = repo rate + margin charged by the lender + risk premium, wherein the margin is the same for all the borrowers, but the risk premium varies.
Therefore, any variation in repo rates will reflect in your home loan EMI payments.
How Repo Rate Affects Your Home loan EMIs?
Any change in the policy repo rate affects both existing and new borrowers. For a home loan linked to RLLR, a repo rate cut by RBI translates into a decrease in interest outgo, so your home loan EMI amount decreases. However, a hike in the repo rate means an increase in the interest outgo leading to an increase in your home loan EMI amount.
Nonetheless, the effective home loan interest rates linked to RLLR depend on various other factors like –
- The home loan amount
- Loan-to-value ratio
- Borrower’s lending risk
- Credit score, etc.
As per RBI, lenders are mandated to revise the RLLR-linked interest rates at least once in every three months; any change in the repo rate will be passed to the borrowers within three months. Moreover, if your credit score improves substantially over the tenure, you can approach the lender to revise the risk premium charged on your home loan and bring down your EMIs.
The Bottom Line
The interest outgo on your home loan repayment determines the overall cost of borrowing. Therefore, use a home loan EMI calculator to estimate the EMI amount before you apply for home loan.
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