MCLR and its effect on home loans

If you plan to take out a home loan from a lending institution, you may come across the term MCLR. Marginal Cost of Funds Based Lending Rate, or MCLR, is one of the crucial aspects which can impact your EMI (equated monthly instalments).

The Reserve Bank of India (RBI) introduced MCLR on 1st April 2016. It refers to the minimum interest rate financial institutions in India can charge for a specific loan. Financial institutions in India cannot lend below the MCLR, or they may face regulatory action. However, in some exceptional cases with prior RBI authorisation, they may lend below the MCLR.

In July 2022, many top financial institutions in India increased their marginal cost of funds-based lending rates across various tenures. After this hike, the EMIs (equated monthly instalments) for various loans, including home loans, may be increased. It is not a good signal for home loan borrowers with floating interest rates. This is because a loan with a floating interest rate sanctioned by a financial institution will be linked to MCLR.

So, it becomes essential to learn more about MCLR and how it can affect your home loans.

Purpose of the marginal cost of funds based on lending rate

MCLR is an advanced and improved version of the base rate. In adopting the MCLR regime, the Reserve Bank of India aims to:

Implement monetary policies properly.
Improve the transmission of the RBI policy rate into institutions’ lending rates.
Bring transparency in the rules followed by various money lending institutions while determining interest rates.
Ensure that institutions can provide loans to borrowers at a competitive interest rate.

Four critical elements of MCLR include:

Tenure premium
Negative carry on Cash Reserve Ratio (CRR)
Operating costs of the bank
The marginal cost of funds

How does MCLR directly affect your home loans?

MCLR is closely linked with the cost of funds of financial institutions and repo rate. So, these institutions adjust their interest rates when the repo rate changes. Thus, any slight change in the repo rate will impact your home loan’s floating interest rate.

For example: If a financial institution brings down the MCLR, the floating rate of interest associated with your housing loan will also come down. It may not affect your monthly EMIs, but your loan tenure can be impacted.

Similarly, in an increasing interest rate scenario, the cost of funds goes up. It will increase the MCLR, increasing loan rates and leading to a higher interest burden.

What can borrowers do in case of an MCLR hike?

When MCLR hikes push up EMIs, you as a home loan borrower can take the following steps to reduce its impact.

Make part pre-payment
Increase the loan tenure to reduce your EMIs

If you have applied for a home loan with a floating interest rate after 1st April 2016, your loan will automatically be linked to the MCLR. If you had taken the loan before this date, you can switch it to MCLR and benefit from it. Also, remember that MCLR does not affect home loans with fixed interest rates.

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