Home Loan Interest Rate

The interest rate of a home loan is a very important aspect and directly influences whether one can afford a loan or not. As mentioned earlier, each EMI of home loan consists of principal and interest components. Hence, getting a competitive home loan interest rate benefits you lifelong. 

Simply put, a home loan interest rate is the cost of borrowing the home loan. It is levied on an annual basis and divided into monthly installments. 

Home loans are given on two kinds of interest rates in India – fixed rate and floating rate. Fixed rate is one which does not change throughout the time period of the loan. 

Floating rate, on the other hand, depends on a variety of factors and hence changes from time to time. This means that sometimes, the interest rate will go up and sometimes down. In most cases, you will get the option to choose which rate you want to avail. 

Some banks/NBFCs also allow switching between the two, but they may charge for such switches and there will be a limit on the number of switches that can be done in a year. 

Factors that affect home loan interest rates

Home loan interest rates are affected by several factors, the primary being:

• RBI repo rate: This is the rate at which the Reserve Bank of India (RBI) lends money to the banks. If the repo rate drops, the interest rate drops as well and vice versa. 
• Cash reserve ratio: This is the amount of money that banks have to keep with RBI as a deposit. If the cash reserve ratio (CRR) falls, banks have more money at their disposal to give out as loans, and hence, the interest rates fall too and vice versa. 
• Demand for loans: Interest rates are also affected by demand and supply of loans in the economy. When demand for loans is high, banks have lesser funds with them to give out, and thus the interest rate goes up. 

Apart from these, interest rates also depend on the borrower’s credentials. For example, if the borrower has a low credit score, the bank may offer the loan at a higher interest rate. 

Should you go for fixed rate or floating rate?

We know, you must be thinking whether the fixed rate is a good idea or the floating rate?

Well, both have their advantages and it is entirely dependent upon you, what you feel comfortable with. 

With a fixed rate of interest, you know the total interest amount you will be paying from the very beginning of the loan tenure. This will help you plan your budget more efficiently.

However, the fixed rate of interest is usually fixed a few basis points higher than the floating rate. Moreover, if you expect interest rates to go up in the near future, the fixed rate will make more sense.

Floating rate of interest, on the other hand, gives you a chance to pay lower interest (and higher too!). If you expect interest rate volatility, then the floating rate will be a better option for you. 

To understand how interest rates can move in the floating rate regime, let us see a quick comparison of the home loan interest rates of SBI from 2011 till 2019: 

A graphical representation of SBI home loan rates
Source: https://sbi.co.in/web/interest-rates/interest-rates/old-interest-rates-last-10-years
*Highest rate in the calendar year has been chosen for illustration purpose
*Rate taken for loans above 30 lakhs and below 75 lakhs

It is difficult to predict whether the interest rate will go up or down, since it is dependent on a number of factors. 

Please note that most banks/NBFCs will let you switch between fixed and floating rates. But switching may include additional costs. Moreover, many banks may not have the option of a fixed rate of interest at all.

Base Rate

While talking about the interest rate, another concept that is important to know is the base rate. Base rate is the minimum rate below which banks are not allowed to lend funds. This is set by the RBI. This has been fixed to increase transparency in the lending market and also ensure that customers get the benefit of the lower cost of funds available to banks. However, the concept of base rate is history now, since the introduction of Marginal Cost of Funds Base Lending Rate. Let’s understand what it is. 

MCLR

If you have been researching about home loans, you must have come across the word MCLR. This is a new method of bank lending introduced from April 1, 2016. Earlier, loans were linked to the base rate. Now, they are linked to the marginal cost of funds based lending rate (MCLR). 

Today, only MCLR-based home loans are available in India. Borrowers who had taken their loans previously and have their loans linked to the base rate have the option to switch to MCLR if they want.

Under this new regime, banks review and declare a range of MCLR rates every month - overnight, one month, three months, six months, one-year, two-years and three-years. The interest rate is decided by adding a spread (an incremental amount) to this MCLR rate. 

For home loans, most banks use the six-month MCLR or 1-year MCLR to fix the interest rates. The bank may or may not add a spread as per its discretion.

For example, as on November 1, 2020, the 6-month MCLR declared by SBI is 6.95% and the home loan interest rate of SBI is also 6.95%. This means, that SBI is providing home loans at MCLR without adding any spread. On the other hand, as on November 1, 2020, the MCLR of HDFC Bank is 6.95% and their home loan interest rates (for 30.01 lakhs and above) is 7.05 – 7.55%, which means they are adding a spread to the MCLR while deciding on the home loan interest rate.

Should you switch from base rate to MCLR?

If you have taken a home loan before 1st April 2016, your loan will be linked to the base rate. In such a scenario, the most common query in your mind will be should you switch? 

Now, there is no standard answer to this question and depends on a case to case basis. The spread that the banks charge on the MCLR is based on the credit rating of the borrower and the spread does not change unless the credit rating of the person changes.

Understand the spread the bank is offering you on the MCLR and also if there are any changes in the terms of the loan. Then take a prudent decision whether it makes any sense for you. 

Keep in mind that once you change from base rate to MCLR, you cannot change back to the base rate.