The Reserve Bank of India recently cut Repo rate by 0.25% from 6.25% p.a. to 6.0% p.a. You have heard that the rate cut by the Reserve Bank will lead to lower EMI. However, despite this rate cut, let’s say, your loan EMI has not gone down. What could be the reasons and what can you do about this? In this post, let’s find out.
#1 Floating vs Fixed
You can expect loan interest rate to come down (in the event of a rate cut) only if your loan is a floating rate loan.
The banks offer loans at fixed rates too. Hence, if you opted for a fixed rate while signing up for the loan, your loan interest rate won’t come down.
You may ask, why would anyone sign up for a fixed rate loan?
Two reasons.
- You expected the interest rates to go up. With a fixed interest rate loan, you do not have to worry about interest rates hikes. Your decision has backfired.
- You knew the pros and cons of a fixed rate loan. Still, you opted for the fixed rate loan because the bank had sweetened the deal. For instance, the floating rate loan was offered at 9.2% and the fixed rate loan was offered at 8.8% p.a.
What can you do now?
- Do nothing. Manage with a fixed rate loan. OR
- Alternatively, you can reach out to your bank and request them to convert this loan to a floating rate loan. This switch from fixed to floating won’t be without a cost. Hence, you must do the cost-benefit analysis. Additionally, you will get the benefit from the subsequent rate cut.
- If your bank is not co-operating and the cost of switch seems high, you can consider transferring your loan to another lender. This is the last resort and may also require a lot of effort. Transferring your loan to another lender may also have cost involved.
#2 Wrong Benchmark
You are on a floating rate loan. However, you must also be on the right kind of floating rate loan.
Floating rate loans are offered on a benchmark interest rate + Spread.
Over the years, the Reserve Bank has kept modifying the methodology for calculating the benchmark interest rate. We have gone from Prime-lending rate (PLR) regime to Base Rate regime to MCLR regime to the current external benchmark regime. Each iteration is more transparent and favourable to the borrower, with a quicker transmission of monetary policy decisions.
But there is a catch.
While the RBI mandated the change in regime for new loans, it did not force banks or the existing borrowers to move to the new regime. You took a loan during MCLR regime in 2017. The external benchmark regime came into force in October 2019. So, any floating rate loans offered by banks from October 2019 were external benchmark (most banks use RBI Repo rate) linked loans. However, your loan taken in 2017 wouldn’t automatically shift to Repo rate regime. You must request your bank to do this.
Now, your bank may not have been completely transparent with you, and you didn’t notice or care. In such a case, your loan rate would still be linked to MCLR. It is not that your loan interest rate cannot go down in an MCLR. It will at some point, but the calculation is convoluted and difficult to understand for most borrowers. The transmission of RBI rate cut may also not be as quick.
Therefore, if you have been living under a rock and don’t know how loan interest rate is calculated (despite being a borrower), you have only yourself to blame. This is where awareness helps you.
Now that you realize your folly, what can you do?
- Request the bank to shift to external benchmark (Repo-rate linked) loan. There may be a cost involved.
- If the bank is not co-operating or charging a big sum for shifting to Repo rate, you can also consider transferring your loan to another lender.
#3 Interest-Rate Reset Frequency
Even if your loan benchmark is RBI Repo rate, it does not mean that your loan interest rate will go down instantly after the Reserve Bank cuts rates. The loan interest rate gets reset on at a specific frequency (as per your loan agreement). So, if your loan interest rate resets every 3 months in March, June, September, and December, you just have to wait out for a few months before the rate cut reflects in your loan rate.
There is nothing to worry about.
Hence, if your loan interest rate has not gone down after RBI rate cut, don’t bother too much. Figure out the reason and act accordingly.