Why Your Loan EMI is Increasing even When Repo Rate & MCLR are Falling

Updated on: 14 Dec 2021 // 27 min read // Home Loans
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If you have availed a Home Loan, Car Loan or a Personal Loan, then you must keep a close eye on the announcements from the Monetary Policy Committee of the Reserve Bank of India. After all, these announcements pertain to the bi-monthly monetary policy reviews, i.e., changes in the benchmark rates.

When during the last few consequent bi-monthly monetary policy reviews, the MPC of the Reserve Bank of India announced cut in the repo rate, your eyes would have been shining with happiness that now the MCLR would also reduce and so would your EMI. But, when on communicating with your lender, you were informed that instead of reducing, your EMI is increasing, you must have been taken aback. After all, how is it possible that when benchmark lending rates- repo rate as well as MCLR are falling, your EMI is increasing? Well, to understand this phenomenon, you need to understand the inter-relation between repo rate, MCLR, and EMIs.

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What is the repo rate?

Repo rate, also known as repurchasing option, is the rate at which banks, private and public sector, borrow money from the Reserve Bank of India. From time to time, banks face a shortage of funds, and to make-up for this shortfall, they must borrow money from the RBI. This allows RBI to exercise a degree of control over the rate of inflation by controlling the money available with banks for circulation in the economy. In order to avail funding from RBI, banks must offer eligible securities.

What is MCLR?

MCLR Rate or Marginal Cost of funds based Lending Rate is the minimum interest rate below which banks do not offer credit facilities to their customers. Though, in exceptional cases, Reserve Bank of India can allow banks to offer interest rates lower than MCLR rates. On 1st April 2016, MCLR rates replaced the erstwhile base rate system, which was used to determine the interest rates for banks. Banks can charge a premium over the MCLR rates to cover their operational costs and profit margins. Customers who already had availed their loans before April 2016, had the option to change to MCLR by paying a conversion fee to the bank.

How the repo rate impacts your EMIs?

In simple terms, as the repo rate determines the cost of borrowing for banks, any changes in the repo rate should directly affect the MCLR rate. Now, since April 2016, interest rates charged by banks are based on MCLR, so any change in MCLR will impact your EMIs in the same way. In theory, a fall in the repo rate should lead to a fall in the MCLR, and a fall in the MCLR rates should lead to a fall in your EMIs. Though, this impact might not be visible straight away as banks take some time to process these changes and make announcements accordingly.

Why your EMI is increasing even while the repo rate and MCLR are falling?

The Monetary Policy Committee of the Reserve Bank of India has announced cuts in the repo rates during all the announcements this year. As a result, the repo rate presently stands at 5.40%, translating into a reduction of 1.10% in 2019. But your EMIs have increased instead of falling. Why so? Read on to know more about this phenomena and when, if at all, will your EMIs fall.

1. Impact on EMI will take time:

Several banks including Punjab National Bank, Central Bank of India, ICICI Bank, Oriental Bank of Commerce have reduced their MCLR rates recently after the announcements of repo rate cut by RBI. In order for the impact of the fall in MCLR to be visible, you will have to wait for some time if you are an existing borrower. For instance, if you are applying for a PNB Housing Loan, the new MCLR applicable in your case would be 7.90% from this month onwards. But if you have an already running PNB Housing Loan, this new rate will not be available for you right away, and you will have to pay according to the previous MCLR rate of 8% announced on 1st July 2019. You need to wait for the reset date of your loan.

2. Relationship with deposit rates:

In the banking and finance industry, it is widely accepted that there will not be any substantial impact on the lending rates to the rates offered on deposits are reduced. Some banks have recently announced cuts in their deposit rates. But due to the impending fears of liquidity crunch, many banks are not prepared to reduce the Fixed Deposit rates. As a result, the chances of many banks lowering the MCLR rates in coming days are bleak, and you will have to bear with the increasing EMIs.

3. EMI is not entirely decided by MCLR:

You must understand that MCLR is the minimum interest rate that the banks can charge against loans offered to customers. But in effect, no bank can afford to function by offering loans at just MCLR rates. All banks thus add a mark-up to the MCLR rates to arrive at their lending rates. It is certainly possible that while the MCLR is falling, banks are increasing the mark-up at the same time, to enhance their profitability.

4. Reset clause:

Home loans based on MCLR come with a reset clause. This reset clause could range between a period of 6 months to 12 months. As a result, if you have opted for a floating interest rate, the Home Loan Interest Rate will be reset only after the expiry of this period. For instance, if MCLR on your Home Loan on 1st September 2017 was 8.75% and after a period of 12 months, the MCLR is now 9.00%, the EMI of your home loan will increase according to this change.

So, you must not wait for your MCLR to fall when you are availing a loan as the real impact of falling repo rate and falling MCLR can take some time to reflect on your EMIs. In the meanwhile you must make all efforts to pay as much money as you can towards your loan repayment, over and above the EMIs, to lead a debt-free life.

It is also important to note here that RBI has directed banks to link their floating rates to external benchmarks such as repo rate and treasury bills rate. This would translate into faster transmission of benchmark rate cut benefit to the customer. However, those who already have MCLR based loans may need to shift to the new regime.

Also Read: The Moneycontrol Show| How Repo-Linked Loans Will Impact Borrowers- With Mr Raj Khosla

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