MCLR v/s Base Rate: Should You Switch Your Home Loan To MCLR ?
Updated on January 2, 2017
There’s a lot of buzz in the news because home loan interest rates have changed from 1st April 2016. The reason for this is that banks have started using a new system to calculate the interest rates for loans. This new system is called ‘Marginal Cost of funds based Lending Rate’ or MCLR (you might need to read the name a couple of times to remember it). This method has been created by RBI and it is mandatory for all banks to use MCLR for loans given after 1st April 2016. Till now, the Base Rate system was being used to calculate interest rate.
Banks announce their MCLR!
On 31st March 2016, State Bank of India became the first bank to announce its range of MCLRs. Lenders like ICICI, Axis Bank and IDBI Bank quickly followed suit by announcing their own MCLRs. You might be confused as to why there are different MCLRs and not just one. Let us explain. Unlike Base Rate which was common for all loans, MCLR is different for loans with different tenors. Tenor is the period after which the interest rate of a loan resets. Basically, the MCLR will be published by the banks each month. If you take a loan with a 1 year tenor in April 2016, then your interest rate will reset in April 2017 and according to the MCLR of that month. And MCLR is different for tenors of 1 month, 3 months, 1 year and so on.
Let’s look at this information from the context of home loans. SBI & ICICI have decided that home loans will have a tenor of 1 year.
For SBI, home loans will be charged MCLR of 9.20%. To calculate the interest rate, SBI will add a Spread of 0.25% on top of the MCLR. Interest Rate = 9.20% + 0.25% = 9.45%. In Base Rate system, SBI’s Spread was the same and Base Rate was 9.30%. So, Interest Rate = Base Rate + Spread = 9.30% + 0.25% = 9.55%. So for SBI, there is a difference of 0.10% between interest rates on Base Rate and MCLR. Similarly, for ICICI Bank, the interest rate on the Base Rate system was 9.65% and on MCLR system, it is now 9.45%. This is a difference of 0.20%.
Great! It’s a lower interest rate! But wait. The question you should ask now is:
Will every home loan be on MCLR?
It is important to clarify this point – NEW home loans will be on MCLR but the loans which have been taken on or before 31st March 2016, will continue to be on the Base Rate system. Here, you have a choice. You can choose to stay on Base Rate till the end of your tenure or you can switch to MCLR. Which brings us to an important question:
Should you switch from Base Rate to MCLR?
For SBI, the MCLR is 10 basis points (0.10%) lower than the Base Rate. For ICICI it is 20 basis points (0.20%) lower than the Base Rate. Also, it is expected that interest rates are on a downward trend and when your interest rate is reset after 1 year, rates will be lower than they are today. So there is short-term benefit in switching to MCLR. However, it is difficult to speculate about the long-term because there are a lot of factors which are still unknown. The upcoming RBI Rate Cut is one of these factors. We do not know how the Rate Cut will impact the interest rates. So here is our recommendation:
Do NOT switch from Base Rate to MCLR.
(EDIT: The massive drop in SBI’s MCLR by 0.90% is an exception to this. People on Base rate MUST explore switching to the new MCLR. Pls see our post here. Also, you can sign up for a free call with our Home Loan Advisors to get personalised advice.)
At least, not immediately. If you have already taken a loan, then we would recommend that you continue on the Base Rate system for now. Once you switch to MCLR, you cannot revert to Base Rate and it would be wiser to wait and find out how well the new system works. If you decide that MCLR is much better than Base Rate, then you can switch immediately. If you feel that Base Rate is better, then no harm done! You can continue on the Base Rate till the end of your loan. You can stay updated with the developments in MCLR by signing up for our newsletter.
To sum up, the MCLR seems like a positive step taken by the RBI to keep the interest rates in-sync with the market conditions. But keep in mind that we are still at the early stages of this system and there are a lot of updates that will come up in the next few weeks and you can follow these updates here. As more developments come our way, we will get a clearer idea of how well MCLR is performing in comparison with Base Rate.
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