# Should I Switch My Home Loan from Base Rate to MCLR

Should I switch my home loan from base rate to MCLR? Many readers of EMICalculator have have asked me this question by e-mail or in a comment on the website. A typical query goes like this:

I have an outstanding loan of, say, 20 lacs at, say, 9.8% per annum. It is a base rate linked loan. My bank has offered me to switch to MCLR linked loan by paying, say, Rs 20,000.  MCLR loan is currently at 9.3% p.a. Should I switch from base rate linked loan to MCLR linked loan by paying the fee?

What will you do in such a case? In this post, let’s see how you should approach this question. As we will see in this post, there cannot be a fixed answer. You will have to work out a few numbers to make a decision.

## Do a Bit of Math

You must see if the savings justify the switch cost. Let’s try to understand with the help of an example.

 Base Rate + Spread 9.80% Loan Amount 20 lacs 40 lacs Outstanding Tenor (Years) 5 10 20 5 10 20 EMI Under Base Rate 42,298 26,209 19,036 84,595 52,418 38,072 Interest under Base Rate 2,537,852 3,145,097 4,568,680 5,075,705 6,290,194 9,137,360 MCLR + Spread 9.50% EMI Under MCLR 42,004 25,880 18,643 84,007 51,759 37,285 Interest under MCLR 2,520,223 3,105,541 4,474,230 5,040,447 6,211,083 8,948,459 Savings in Interest Cost 17,629 39,556 94,450 35,258 79,112 188,901 MCLR + Spread 9.25% EMI Under MCLR 41,760 25,607 18,317 83,520 51,213 36,635 Interest under MCLR 2,505,588 3,072,785 4,396,161 5,011,176 6,145,571 8,792,322 Savings in Interest Cost 32,265 72,312 172,519 64,529 144,624 345,039 MCLR + Spread 9.00% MCLR + Spread 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% EMI Under MCLR 41,517 25,335 17,995 83,033 50,670 35,989 Interest under MCLR 2,491,003 3,040,219 4,318,685 4,982,005 6,080,437 8,637,369 Savings in Interest Cost 46,850 104,879 249,995 93,700 209,757 499,991

You can see that your savings increase with the increase in loan amount, loan tenor and the interest rate differential. However, there is an issue with the above approach. Typically, the bank does not alter the EMI based on change in underlying interest rate. It merely changes the tenor. If the bank alters the tenor (and not the EMI), your savings will only be towards the end of the loan tenor.  Let’s see how the numbers look like in case of adjustment in tenor (and not EMI).

 Base Rate + Spread 9.80% Loan Amount 20 lacs 40 lacs Outstanding Tenor (Years) 5 10 20 5 10 20 EMI 42,298 26,209 19,036 84,595 52,418 38,072 Original number of Instalments (in months) 60.00 120.00 240.00 60.00 120.00 240.00 MCLR + Spread 9.50% New number of Instalments (in months) 59.47 117.51 226.02 59.47 117.51 226.02 Net Savings 22,496 65,238 266,064 44,992 130,477 532,129 MCLR + Spread 9.25% New number of Instalments (in months) 59.03 115.55 216.18 59.03 115.55 216.18 Net Savings 40,832 116,711 453,424 81,663 233,422 906,849 MCLR + Spread 9.00% New number of Instalments (in months) 58.61 113.67 207.58 58.61 113.67 207.58 Net Savings 58,808 165,783 617,141 117,615 331,565 1,234,283

You can see the savings in the second approach are much higher as compared to the first approach. However, don’t get confused. In the first approach, you are saving every month in terms of reduced EMI. On the other hand, in the second approach, you are saving only towards the end of the loan tenor. That’s why the numbers look higher in the second approach.

In this post, I will consider second approach unless specifically mentioned. A point to note is that I have assumed interest rate to be constant throughout the loan tenor, which is not a practical choice. It is quite possible that the difference in base rate or MCLR may narrow down or widen in the future. However, it is not possible for me to forecast base rate and MCLR. Hence, I will stick to this analysis only.

## Compare the Savings with the Switch Fee

Now that you know the net savings, you must compare it against the switch fee. Let’s consider two cases.

1. For a loan of Rs 40 lacs with tenor of 20 years and interest rate of 9.8%, the savings from switching to MCLR rate of 9.25% will be approximately 9.06 lacs. Now, suppose the bank offers you to switch your loan to MCLR at a fee of Rs 50,000, should your switch? Rs 50,000 is a very small number as compared to Rs 9.06 lacs. However, you have to shell out Rs 50,000 today while saving of Rs 9.06 lacs is spread from 18th till 20th year. You need to account for this difference in timing of cash flow. Rs 50,000 if invested at 8% will grow to Rs 2.33 lacs. Even if you can find an investment that delivers a return of 10% p.a., Rs 50,000 will only grow to Rs 3.36 lacs. Hence, it makes sense to switch.
2. If the bank had demanded Rs 50,000 for a 5 year loan (switch from 9.8% to 9.5%), your net saving is only Rs 44,992. Rs 50,000, if invested at 8%, will grow to Rs 73,466 in 5 years. Hence, it does not make much sense to switch.

Clearly, you benefit more from the switch when:

• The outstanding loan amount is higher
• Difference between base rate and MCLR is high. Consider the spread too.
• Outstanding tenor is high.
• Switch fee is lower.

## Do You Plan to Prepay the Loan?

You must absolutely consider this aspect. We have seen the net savings from the switch are low when the loan amount is small and the loan tenor are short. If you plan to prepay the loan, the loan tenor will go down and the outstanding principal will also go down sharply. In such a case, rather than paying a fee to switch loan to MCLR, consider pre-paying the loan with the switch fee amount.

For instance, suppose you have loan of Rs 20 lacs at 9.8% for 5 years. Your bank is asking for a fee of Rs 30,000 (incl. service tax) to switch loan to MCLR at 9.25%. By switching loan to MCLR, you will save Rs 40,832. However, by prepaying home loan with the same Rs 30,000, you will save Rs 49,109. In this specific case, it makes more sense to prepay rather than switch to MCLR. I am not saying that the mathematical outcome will always support pre-paying the loan with the switch fee amount. It may or may not.

I have chosen the example to suit any argument. You must work out the numbers for your specific case. Do consider the ‘Switch to MCLR’ aspect. Similarly, if you are planning to prepay your loan aggressively, the benefits of switch to a lower rate will go down. In such a case, do consider pre-paying rather than switching to MCLR.

## Points to Note

1. Your bank may charge a flat fee or a percentage of the outstanding loan. It is completely bank’s discretion. However, the way to analyse remains the same.
2. Your bank will also charge service tax on the switch fee.
3. MCLR can a double edged sword. Just like MCLR linked loan rates are likely to move down faster (than base rate linked loan) when interest rates are going down in the economy, MCLR rate will rise just as swiftly when the interest rates move up. However, given the banks’ propensity to pass on rate hikes much quicker than passing on interest rate cuts, I wouldn’t worry much about this aspect.
4. MCLR has an associated interest rate reset period. So, if your home loan is linked to 1-year MCLR, your interest reset dates will be 1-year apart. Hence, even if 1-year MCLR moves down in the interim, your applicable interest rate will change only on the next interest reset date.

MCLR is more transparent than the base rate. I am not saying banks will not figure out a way. I think the banks already are. However, I feel they have much more leeway in case of base rate. Hence, everything else being the same, MCLR is a better option than base rate. However, do not rush to switch. Do your math and make an informed decision subsequently.

## 3 responses to “Should I Switch My Home Loan from Base Rate to MCLR”

1. Raja says:

Excellent explanation. Would be really helpful if you created a calculator in xls to calculate whether the switch to MCLR will be useful

2. Hitesh says:

I have home loan from axis of 16 lakhs for 20 years which is 90% disbursed till now. My base rate is 9.15%. MCLR is now 8.65 % of Axis . I have 18 years tenure left . My Base Rate has spread 0 i.e 9.15%+0 %.Shall I switch to MCLR. If yes shall I switch to SBI or Axis.

3. amit says:

I have home loan from axis of 9.34 lakhs for 20 years which is 90% disbursed till now. My base rate is 9.15%. MCLR is now 8.65 % of Axis . I have 14 years tenure left . My Base Rate has spread 0 i.e 9.15%+0 %.Shall I switch to MCLR. and bank ask for 2500 + service tax as free
plz revert
amit