Should You Switch from MCLR to EBR (or External Benchmark Loan)?

The bank must link all new floating rate loans to retail customers loans from October 1, 2019 to an external benchmark. The Reserve Bank notified the change in its circular dated September 4, 2019. This means MCLR will soon be history, at least for retail borrowers. Starting October 1, no new floating rate loans will be linked to MCLR. What could be the external benchmarks? If you are an existing borrower under Base Rate or MCLR, what should you do? What are the other aspects you must keep in mind? Let’s find out.



The External Benchmark Need Not Just Be the Repo Rate

In July, 2019, the State Bank of India had launched a home loan product linked to Repo rate (an external benchmark). The Benchmark is called RLLR (Repo Linked Loan Rate). RLLR is RBI Repo Rate + 2.25%. The loans were offered spread over RLLR. Therefore, RLLR was withdrawn and a new benchmark (External benchmark-linked rate) was launched towards the end of September, 2019. Even though the linkage is to the Repo, the benchmark spread has been increased to 2.65%. 

Citibank has a home loan product where the interest rate benchmark is 3-month Treasury yield. This product was launched way back in March 2018, much before RBI notified this change.

Your bank can choose any of the above external rates as the benchmark.

  • RBI Repo Rate
  • Government of India 3-Months or 6-months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL)
  • Any other benchmark market interest rate published by the FBIL

Your bank may have already launched similar home loan product. From what I have seen, most of the banks are using RBI Repo rate as the external benchmark.

I Have an Existing Home Loan. Can I Switch to EBR or the External Benchmark Loan?

If you are a new borrower, you don’t have any choice since your loan will be linked to an external benchmark. However, if you are an existing borrower and your loan is linked to MCLR or base rate, you will get an option to switch to external benchmark. As per the RBI circular, if your loan is a floating rate loan and has no prepayment penalty, you will get an option to switch to the external benchmark. It won’t happen automatically. You will have to request your bank. Remember switch from Base Rate or MCLR to an external benchmark is a one-way street. You can’t switch back.

Should I Switch from MCLR/Base Rate to Repo Rate or Any Other External Benchmark?

When MCLR regime was introduced a few years back, many of us had to make a similar decision. Should you switch to the new benchmark? MCLR seemed more transparent than the base rate and thus clearly had an upper hand. The borrowers had to choose between one of the following three.

  1. Maintain the status quo i.e. stick with base rate.
  2. Switch without paying a fee. In this case, your pre-switch and post-switch interest rate remained the same. i.e., the spread was adjusted to keep the interest rate constant. For instance, if your loan interest rate was 9% p.a. under base rate and MCLR was 8.25%, your spread will be 0.75%. Had the loan interest rate been 8.75%, your spread would have been 0.5% p.a. I have highlighted the issues of a higher spread in an earlier post.
  3. Switch after paying a fee to a lower rate. The fee was a fixed amount in some cases while a percentage of outstanding loan amount in the others. In this case, you could get a lower rate, but you must pay a fee for it. Here, it was all about cost-benefit analysis. You had a cost in the form of fee and the benefit in the form of lower EMI due to lower rate of interest. I have discussed the decision process in detail in this post.

What about Base rate/MCLR to an external benchmark? RBI circular takes cognisance of this scenario too and mentions the following:

[Such borrowers] shall be eligible for switchover to External Benchmark without any charges/fees, except reasonable administrative/ legal costs.

As I see, there shouldn’t be a significant fee impact even if you were to switch to the external benchmark. Favourable for borrowers. At the same time, the banks may have a very different interpretation of administrative/legal costs.

The circular further adds:

The final rate charged to this category of borrowers, post switchover to external benchmark, shall be same as the rate charged for a new loan of the same category, type, tenor and amount, at the time of origination of the loan.

This is also important. As I understand, the bank won’t be able to tinker around with your loan spread just to keep the interest same as before the switch. The rate must be in line with what the new borrower will get. In my opinion, this means if a new borrower with your credit profile can get a new loan at 8.25% p.a. and your existing loan is at 8.75% pa., you should also get 8.25% p.a. post the switch. And this should be allowed without any expensive charges. Please note this is my understanding. The banks may have a completely different interpretation of the RBI rules.

As I see, you will have 2 options.

  1. Maintain status quo. Stick with Base Rate or MCLR.
  2. Shift to EBR (for SBI borrowers) or any other benchmark at a very reasonable cost. By the way, “Reasonable” may have a different meaning for you and the bank. You know what I mean. Clearly, you will agree to this switch if the externally benchmarked loan is cheaper than your existing loan.

The decision-making should be fairly simple in such a scenario. If the new loan is lower, switch or you must wait. By the way, if you aren’t getting a good deal from your bank, you can always explore options outside of your bank. However, changing the lender (refinancing your loan) is operationally challenging. There will be minor additional expenses too. I assume you find merit in an external benchmark.

Points to Note

The RBI circular applies only to the banks. Housing Finance Companies (HFC) such as HDFC, LIC Housing Finance etc.  do not have to shift to an external benchmark, as of now. Therefore, if you have taken a home loan from an HFC, you will have to look out if you want to shift to an external benchmark.

Home loans are offered at a Benchmark + Spread. The benchmark keeps changing. Spread will typically remain constant during your loan tenure. Therefore, keep an eye on the spread. If you happen to contract your loan at a higher spread, it can pinch you later.  Though the post is about MCLR spread, the concept remains the same.

The aforesaid RBI circular dated September 4, 2019 applies to only floating rate loans. If your loan is fixed rate loan, nothing changes for you. Makes sense too.

The loan interest rate under the externally benchmarked loan will be reset at least once in 3 months. SBI EBR loans reset every month. With MCLR, the banks typically kept reset periods at 6 months or 1 year. Shorter reset periods help in quicker monetary policy transmission.

The bank can use only 1 benchmark for a particular category of loans. For instance, it can’t benchmark a few home loans to Repo and the others to 3-month Treasury yields.

Even though the spread is expected to be constant, the bank can change the spread if there is a change in credit profile. There is a provision that permits change in spread due to change in operating costs once in 3 years.

Facing this dilemma about switch to external benchmark or not? Let’s us know in the comments section.



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