Usually, when the Reserve Bank of India cuts the repo rate, it is expected to bring some financial respite to borrowers—especially home loan borrowers. It is because the repo rate, the rate at which the RBI lends money to commercial banks in India, directly influences lending rates in the economy. Lower repo rates should ideally translate into lower interest rates on loans, which in turn should reduce monthly EMIs. However, many home loan borrowers have recently found themselves disappointed.
The Reserve Bank of India has recently reduced the repo rate three times this year, bringing the total cut to 100 basis points. As a result, home loan interest rates have fallen below 8%, a level last seen in 2022, providing a potential lifeline for borrowers facing high interest rates. Despite these significant regulatory changes, many borrowers are finding that their EMIs remain unchanged.
This gap between repo rate cuts and unchanged EMIs isn’t accidental—it mainly happens because of how home loans are structured and more specifically, from the benchmark to which they are linked. Whether or not a borrower benefits from the RBI’s rate cuts often depends on this one critical factor, which plays a pivotal role in interest rate transmission and borrower benefit.
Understanding the Link Between Repo Rate and Lending Rates
Traditionally, when the RBI reduced the repo rate, commercial banks were expected to pass the benefit on to customers by cutting loan interest rates. This is based on the idea that lower borrowing for banks leads to cheaper lending for customers.
To make this system more transparent, in October 2019, the RBI mandated that all new floating rate retail loans, including home loans, must be linked to an external benchmark. The most commonly used benchmark is the RBI’s repo rate. This change was aimed at improving the speed and transparency of rate transmission to the end user. Then why are EMIs still high for home loan borrowers?
While the repo rate may have come down, the actual lending rate you are charged—known as the Effective Interest Rate (EIR) depends on more than just the benchmark. Let’s discuss this in detail:
1. Spread or Margin Added by Banks
When banks lend money, they don’t do so at the benchmark rate itself. They add a spread or margin to the repo rate to cover their operational costs, credit risks, and profit margins. This spread is decided at the time of loan sanction and, in many cases, remains fixed for the duration of the loan. So even if the repo rate drops, your total interest rate may not fall significantly unless the bank reduces its spread—which is unlikely.
2. Reset Periods and Lag in Transmission
Another hidden issue is your loan’s reset frequency. Even if your loan is tied to the repo rate, interest rates are usually updated only every three to twelve months, depending on your lender’s reset approach. So, for instance, if the RBI further lowers the repo rate in June and your loan’s interest rate is scheduled to be revised in December, you won’t realize the advantage for several months.
3. Risk-Based Pricing Models
Banks have also increasingly adopted risk-based pricing, which means the final interest rate offered to a borrower depends on their credit profile, loan-to-value ratio, and overall risk assessment. So, if your credit score is average or if the lender sees your loan as higher risk, you may not get the best rates even if the repo rate drops.
Internal Benchmark vs External Benchmark
Not all borrowers are on repo-linked loans. If your loan was taken before October 2019 and hasn’t been converted to the external benchmark system, it might still be linked to older benchmarks such as the Marginal Cost of Funds based Lending Rate (MCLR) or even Base Rate. These benchmarks are far slower in responding to changes in the RBI’s policy rates.
For example, MCLR takes into account a bank’s cost of funds, operational costs, and risk premium. This makes it less sensitive to repo rate changes. So even with a repo rate cut, borrowers on MCLR-linked loans may not see any immediate benefit.
What Can Home Loan Borrowers Do?
If you are still not experiencing a drop in your EMI despite repo rate changes, here are a few practical things you can take:
1. Check Your Loan Type
Consider whether your loan is tied to the repo rate or remains based on the MCLR or Base Rate. If it is not repo-linked, try switching.
2. Request a Conversion
Most banks allow customers to convert from MCLR-based loans to repo-linked loans for a small charge. This could result in large savings over time.
3. Compare Interest Rates Across Lenders
Sometimes, switching lenders can offer better interest rates, especially if other banks are offering more competitive spreads.
4. Improve Your Credit Score
Since creditworthiness is a key factor in determining your loan’s spread, maintaining a high credit score can help you secure better terms.
Conclusion
While RBI’s recent decision of slashing repo rate is making headlines all across the country, the reality on the ground for borrowers is more nuanced. Your home loan EMI is not just a function of the central bank’s policy decisions but also of your bank’s internal pricing strategy, your loan agreement terms, and your own credit profile.
Notably, the lack of relief in EMIs despite a repo rate cut isn’t always due to inefficiency in the system—it’s often due to structural reasons embedded in loan agreements and bank policies. For real savings, borrowers need to stay informed, ask the right questions, and be proactive in managing their home loans.