In December 2018, RBI had proposed that all fresh floating rate loans from April 1, 2019 must be linked to an external benchmark. The implementation has since been deferred. It is now up to the banks to come up with products linked to an external benchmark. Citibank had launched a home loan product in the first half of 2018 that is linked to 3-month Treasury Bill Benchmark rate. Now, the State Bank has jumped in. Starting July 1, 2019, new home loan borrowers will have an option to get Repo rate linked home loan. i.e., their home loan interest rate will be benchmarked to repo rate.
How Will SBI Repo Rate Linked Home Loan Work?
Under Repo-rate linked home loan product from SBI, the benchmark is the Repo-Linked Lending Rate (RLLR), which in turn is linked to the repo rate set by the Reserve Bank of India. Repo rate is the interest rate at which the Reserve bank lends to other banks. Repo rate is a monetary policy instrument announced by the Reserve Bank in its six-weekly meetings. Do note RBI can change repo rate out of turn and does not have to wait for the policy meetings to announce changes. Through repo rate, the Reserve Bank tries to balance its various objectives such as growth, inflation and employment.
Home loans are offered at a benchmark + spread. RLLR, MCLR and before that, base rate and PLR, are all benchmarks. Benchmark is the same for all borrowers. The spread may depend on the quantum of loans, creditworthiness (credit score) and your profession/employment status. For instance, a salaried person may get the loan at a lower rate of interest as compared to a self-employed borrower.
Repo-linked lending rate (RLLR) is repo rate + 2.25%. Currently the repo rate is 5.75% p.a. Therefore, RLLR shall be 8% p.a. The borrowers will be charged a spread over the RLLR. As mentioned above, the spread will vary across borrowers.
SBI Repo Rate Linked Home Loan: Points to Note
- You must have a minimum annual income of Rs 6 lacs.
- The maximum loan tenure can be 35 years.
- Under RLLR linked loan, the loan repayment shall be such that you repay at least 3% of the principal amount every year. As I see, the EMI calculation will be very different from plain vanilla home loans. Under regular home loans, the principal repayment is quite low in the initial years.
- There is no clarity about the reset period. i.e., how frequently will your interest rate change? Banks have different reset periods for MCLR. State Bank of India uses 1-year MCLR. This means your loan interest rate will change only at gaps of 1 year. Remember, the MCLR for the bank can change every month.
- There is no clarity about whether existing MCLR borrowers will get an option to shift to RLLR linked loans.
What Are the Benefits of Such a Loan Product?
Repo rate is decided by the Reserve Bank. The State Bank of India or any other bank has no role to play. Many borrowers have this discomfort that the banks are quick to pass on the rate hikes (repo) but not so keen to pass on the rate cuts. RBI also has this discomfort because if banks don’t pass on the lower/higher rates to the borrowers, it impedes policy transmission. After all, the RBI does not lend to the end-users. Only banks and financial institutions do.
By the way, the bank may not be able to pass on the repo rate cuts to MCLR linked borrowers for various reasons. For instance, the banks may not be able to cut rates on fixed deposits due to competition from small savings schemes. Therefore, their MCLR (which is linked incremental cost of borrowing) may not fall as much as the repo rate. So, it may not just be a result of intentions.
As a borrower, RLLR is clearly more transparent. You can’t possibly do MCLR calculations on our own. You must go by what your bank says. No such issues with RLLR. If you are one of those who doesn’t trust banks, RLLR is a clear winner.
What Could Be the Drawbacks?
As a new borrower, don’t expect much difference between the MCLR linked loan and RLLR linked loan. Your spread would be adjusted so that the cost is almost similar under both the cases. The key lies in what happens thereafter. We don’t yet know about the reset periods. If the reset frequency is higher, your loan interest rate and the EMI may change frequently.
With relation to this specific product, since a minimum of 3% principal repayment must be made every year, your monthly payments during the initial years could be high (as compared to regular EMI. This could lead to a lower loan eligibility under this product. Do note this minimum principal repayment is specific to this product. There is no RBI guideline in this regard. Since the cost of borrowing for the bank can be very different from the repo, this could be a strategy by the bank to guard against the interest rate risk.
What Should You Do?
It is reasonable to assume that banks will pass on the rate hikes quickly even if you were on MCLR. It is for the rate cuts that you are not sure about their behaviour. This gets taken care of with RLLR. While there is still a question mark over the reset period, a RLLR linked loan looks like a good choice.
Disclosure: Much of the information shared in this post has been solicited various new articles about the loan product. As of now, there is no information about this product on the SBI home loan website. Once the product is formally launched in July 2019, I will share more information about the product.