For borrowers, this is good news, especially for those whose loans are linked to external benchmarks like the repo rate. However, for fixed deposit (FD) investors, the latest rate cut is likely to further reduce the interest rates on deposits and pinch their pockets.
The RBI, today, cut the repo rate by 40 basis points (bps) (100 basis points/bps = 1 per cent). The repo rate now stands at 4 per cent and reserve repo rate at 3.35 per cent. The apex bank last cut rates in its March 2020 in an advanced monetary policy review. In total, they have cut the repo rate by 115 bps since the lockdown started.
Here is a look at how today’s rate cut will impact FD investors and borrowers, both existing and new.
Interest income from FDs likely to fall further
The latest rate cut is likely to cause more heart ache for FD investors, especially senior citizens who are dependent on interest income. Post RBI’s last rate cut in March, 2020, the country’s largest lender announced a reduction in fixed deposit interest rate by up to 50 bps. The rates were further revised on May 12, 2020.
Currently, one year SBI fixed deposit is offering 5.50 per cent, for senior citizens, the interest rate on one year fixed deposit is higher by 50 bps i.e. 6 per cent.
Those investors looking for fixed income avenues, can consider investing in RBI taxable 7.75% bonds, Senior citizens savings scheme and PM Vaya Vandana Yojana. At present, these schemes are earning more than 7 per cent per annum.
Impact of the rate cut on borrowers
This rate cut is likely to reduce equated monthly instalments (EMIs) of borrowers, and also make it cheaper to take new loans.
Here’s an example of how your home loan is likely to be impacted under the new external benchmark regime.
|Loan Amount (Rs)||3000000|
|Current Interest Rate (%)||7.40|
|Current EMI (Rs)||23,985|
|New Interest rate (%)||7|
|New EMI (Rs)||23259|
|Cut in EMI (Rs)||726|
SBI’s term loan interest rate for a loan up to Rs 30 lakh for male, salaried borrower. The interest rate is linked to repo rate.
Here’s what different types of borrowers can do after today’s rate cut.
A) With loans linked to external benchmark
Borrowers whose loans are linked with an external benchmark. i.e., repo rate, treasury-bills etc. as mandated by the RBI can expect to see their EMIs coming down in the next three months. This is because as per RBI’s circular on linking of loan interest rates to an external benchmark dated September 4, 2019, the rates have to be reviewed and reset by banks atleast once every three months.
Therefore, today’s rate cut will lower a borrower’s EMI outgo in the next three months. This is the third time RBI has cut the repo rate after the new lending rate regime came into effect from October 1, 2019.
However, if your bank hikes the margin on the external benchmark rate, then it is likely that the rate cut by RBI will be fully impact the interest rate charged on loan in the future.
B) With loans linked to MCLR
Borrowers whose loans are linked to the marginal cost-based lending rate (MCLR) will benefit only when their bank reduces loan rates. This is because MCLR is dependent on not just external factors such as rate cut but also on the internal factors of the bank. Further, the reduction in MCLR will translate into lower EMIs only when the reset date of your home loan arrives.
Usually, a bank offers home loans with reset period of six months or one year. On the reset date, your future EMIs will be calculated on the basis of the interest rate (bank’s MCLR plus margin of the bank) prevailing on that date (i.e. reset date).
Currently, one-year SBI MCLR stands at 7.25 per cent and six-month MCLR stands at 7.20.
If you want to switch from an MCLR-based loan to an external benchmark one, then you can do this by paying an administrative cost. However, financial planners suggest that one should make a switch only if the interest rate difference between the two is 0.50 per cent or more.
B) With loans linked to base rate or BPLR
Borrowers whose home loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR) should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of policy rates in comparison with base rate and BPLR rate-linked loans, as per financial planners and industry experts.
The Finance Minister, Nirmala Sitharaman in the Atmanirbhar Bharat Package, announced the extension of credit linked subsidy under Pradhan Mantri Awas Yojana till March 2021. Under the PMAY scheme, middle income group – I (MIG -I) with income between Rs 6 lakh and Rs 12 lakh can avail interest subsidy of 4 per cent whereas middle income group – II (MIG -II) with income between Rs 12 lakh and 18 lakh can get interest subsidy of 3 per cent under the scheme.
Therefore, the recent rate cut will make the new loans cheaper. While availing a loan linked to an external benchmark, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the cheapest interest rate.
Further, some banks are offering loans linked to external benchmark which is not repo rate. As per RBI report in April 2020, six banks are offering interest rate linked to CD rates, treasury bills etc. instead of repo rate.
But do keep in mind that when RBI starts to hike key rates, your interest rates will go up in tandem. So external benchmark linked interest rates are likely to be more volatile than the MCLR linked rates.