You must have heard on business channels and read in newspapers that a repo rate cut is good news for home loan customers.
But do you really understand why it is so?
Repo rate is the rate at which the RBI lends money to Indian banks. So when RBI cuts repo rate, it helps banks as they can now get money at a cheaper rate. As the cost of raising funds for lenders goes down, the lenders are normally expected to pass on the benefits to borrowers by means of loan rate cuts (applicable for floating rate loans). This is the reason that home loan customer rejoice whenever there is news of repo rate reduction.
Let’s see what happens when after repo rate cut, a lender decides to reduce the home loan rates for floating-rate loans by 0.5%
For a loan of Rs 50 lacs that was to be repaid in 20 years, a interest rate cut of 0.5% (from 10% to 9.5%), will reduce the home loan EMI from Rs. 48,251 to Rs 46,606. Or else, if borrower decides to keep the EMI same, the repayment term gets reduced to 18 years 2 months instead of 20 years. Though it’s totally up to the borrower whether he/she wants to reduce the EMI or the tenure, expert’s advice that it’s better to reduce the tenure and be done with the loan at the earliest.
But mind you that repo rate cuts don’t translate into loan rate cuts immediately. Lenders generally cut rates after a quarter or two of the RBI move and hence, there is a lag of few months. It’s also possible that lenders may ignore the rate cut and decide not to pass on the benefit to the borrowers.
Typically, it’s best to opt for a floating rate loan when chances of rate cut in near future are high.
