You can now enjoy a lower interest rate thanks to the implementation of MCLR. However, will it affect your loan eligibility? Read on to find out.
From April 1st 2016 onwards, banks and NBFCs have been instructed by the Reserve Bank of India (RBI) to shift to a new system of setting loan rates. Termed as Marginal Cost-of-funds-based Lending Rate (or MCLR) system, under this system, the lending institutions link their loan rates to marginal funding costs.
The RBI wants to ensure that banks and NBFCs reduce their lending rates whenever the repo rates fall by using this system, implying that this policy will only impact loans that have a floating rate of interest.
Key Features of MCLR
Here are some of the things that you need to know about MCLR:
1. The margin over the MCLR base rate will remain fixed from the time of sanction and this can’t be changed unless there is a change in the borrower’s profile
2. The banks and NBFCs need to submit a minimum of five MCLR rates or reset clauses—overnight, one-month, three-month, six-month, and one-year— which will depend on the tenure of your loan
3. The MCLR system will not affect your EMIs
4. The banks and NBFCs can revise their MCLR rate every month
5. Loans sanctioned before April 1st 2016, under the old base rate system, will remain unaffected, but borrowers can move to the new system by paying a fee
So, how exactly is this new system going to affect Personal Loans? Will Personal Loans become cheaper? Let’s have a look at it in detail:
A Personal Loan can be the answer to short term liquidity issues. Most people assume that since banks and NBFCs are adopting the new MCLR system to set floating interest rates, the lending rates will go down substantially, at least in case of short-term personal loans.
The reasons for this assumption can be found below:
The main reason why people are anticipating a drop in the lending rates is the very purpose of implementing the MCLR system—to make loans cheaper for Indian borrowers.
The repo rates dropped manifold in the last few months but its effect didn’t reach to borrowers. The banks and NBFCs didn’t reduce their rates to the same extent, and that is how things work under the base rate or average cost of fund method. Factors affecting this include interest that banks and NBFCs need to pay for deposits, operating costs, maintenance cost of their cash reserve ratio, and of course, a minimum profit margin. Since the lending rates didn’t get directly affected by the change in repo rates, its effect couldn’t be felt by customers.
This led the RBI to bring in a system where customers could benefit from the changes in the repo rate and hence, the MCLR system. The RBI has mandated all lending institutions adopt this new system and implement it with immediate effect. Under this system, banks and NBFCs have to calculate their overall costs of funds every month, ensuring that borrowers get the benefits of changing rates, and making sure there is uniformity between the repo rate and the lending rate.
MCLR Calculation Method
Apart from the number of the calculations made, there are other factors responsible for bringing down the rate of interest. The marginal cost of fund is based on many factors, which include the likes of the interest charges on deposits, rate at which banks and NBFCs borrow from the RBI (or the RBI lends to banks and NBFCs) or the repo rate, cash reserve ratio, premium on the remaining tenure (premium tenor), and operating costs.
The credit risk premium gets added onto the MCLR for the final rate of interest, from the point of view of the borrower.
Considering the fact that MCLR is directly related to repo rates, and will be calculated every month based on the prevailing market conditions, the interest rates are expected to fall further with the 25 points basis point cut by the apex bank on 5th April 2016, and so happy times for the borrower are expected to stay for a while. Loans are likely to become more affordable and your Personal Loan EMI will be lower.
Tenure premium is what is going to make the biggest difference in terms of lending rate calculation under MCLR. Banks and NBFCs never used to consider the tenure while calculating the interest rates. They didn’t lend money below their base rates, even in case of short term loans with a tenure of 3 months.
However, now, under MCLR, the lending rate will depend on the tenure of the loan. If you opt for a short term loan, then you are likely to get a lower rate of interest as compared to the existing base rate, meaning you’ll pay a lower Personal Loan interest rate in the long run.
MCLR and Prospective Borrowers
Under the MCLR systems, banks and NBFCs will have to amend their lending rates as soon as the RBI reduces its repo rate, which means that you, the borrower, will get the benefits immediately, unlike during the old base rate system.
MCLR and Existing Borrowers
If you’ve borrowed a loan after April 1st 2016, then your lending rates would be determined under the MCLR system. And if you’ve borrowed before that, then you can make the move to this new system by paying a small fee.
It is important for you to understand that MCLR system has been linked to floating interest rates only, whether you opt for a Personal Loan, Home Loan, Car Loan, or Student Loan. It’s not going to affect you in any way if you have borrowed money under a fixed interest rate scheme or you’re planning to do so.
For customers under floating interest rate schemes, the lending rates will depend on the repo rates and any changes will be reflected from the reset date onwards.