On 15th Jan 2015, the Bombay Stock Exchange index (BSE – Sensex) surged around 700 points, its biggest single-day gain in eight months. On the same day, major nationalized banks like Union Bank of India and United Bank of India cut their Base Lending Rates (BLR). The next day all major Newspapers carried an important headline and that is about “RBI cuts key interest rate.’”
Reserve Bank of India (RBI) has cut Repo Rate by 25 Basis points (0.25%) on 15th Jan, 2015. RBI Governor unexpectedly and surprisingly has cut interest rates for the first time in nearly 2 years. This had brought cheer to the Equity markets and the investors. (1% is equivalent to 100 basis points)
What are these rates? Why a repo rate cut of just 0.25% is so important and powerful? What does RBI rate cut means to you and me? What is the impact of RBI’s rate cut on home loan and other loan EMIs (Equated Monthly Installments)? Is this the right time to buy a property through a home loan? Can we expect home loan interest rates to fall in 2015?….I believe you may have these questions running in your mind now????
To control/manage inflation and the economic growth , RBI uses certain tools like CASH RESERVE RATIO (CRR), STATUTORY LIQUIDITY RATIO (SLR), REPO RATE, REVERSE REPO RATE etc., Let us now try to understand more about these ratios.
RBI cuts Repo rate – What is Repo Rate?
When we need money, we take loans from banks, banks charge certain interest rate on these loans. This is called as cost of credit (the rate at which we borrow the money).
Similarly, when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to the central bank (RBI) is known as “Repo Rate.” Repo rate is short form of Repurchase Rate.
Example – If repo rate is 7% , and bank takes loan of Rs 1000 from RBI , they will pay interest of Rs 70 to RBI. (The current Repo-rate is 7.75% as of January 2015)
(Read: “What is CRR,SLR,Repo-rate and Reverse Repo rate” to know more about these key rates)
So, higher the repo rate higher the cost of short-term money and vice verse. If the repo rate is low, banks have to pay lower interest amount on their borrowings. This in turn enable them charge lower interest rates on the loans taken by us. Lower repo rate can also strengthen positive momentum in the economy. These are the main reasons for markets turning ecstatic during last few days.
Currently crude oil (petrol/fuel) prices, commodity prices and inflation have eased and are at very comfortable levels. Against this backdrop, RATE CUT was imminent.
Impact of RBI Rate cuts
The below graphical illustration shows you about the impact of RBI’s rate cuts on Deposit Rates, Lending rates, Money supply in economy, economic growth and purchasing power of consumers.
Impact of RBI Rate cuts on Home Loans & lending rates
All most all banks & non-banking financial institutions have said that they are going to cut Lending rates immediately or in very near future (likely by March 2015).
State run lenders United Bank of India and Union Bank of India were the first to cut their Base Lending rate (the lowest lending rate) by 0.25% to 10%. State Bank of India has already cut its Deposit rates signaling (which will bring down its cost of funds) the downward trend of the home loan or lending interest rates.
Let us go through some more important points on ‘how the RBI’s rate cuts impact our Home Loans..’
- The RBI’s rate cuts does not necessarily mean that the borrowers benefit immediately. Your banker has to reduce its Base Lending rate. If your bank reduces the base rate then only you can see your Loan EMIs falling
- These rate cuts will not have any impact on Fixed rate home loans or Fixed rate consumer loans. The rate of interest is fixed with respect to fixed loans.
- The existing bank customers (who have taken loans) can see either their Loan tenures or EMIs coming down. By default the banks reduce the loan tenure instead of loan EMI. That means your monthly EMI installment amount remains the same. The rate cut will make a substantial difference if the remaining loan term/tenure is very long.
- If you want to get EMI reduced, you may have to contact your banker or lender to reset the term and conditions. Also, don’t forget to submit new ECS mandate for new EMI amount.
- If you have plans to acquire a property through a home loan, suggest you to wait for some more time. Home loan interest rates may moderate even more in this year (2015). You may see interest rates falling below 10%.
- As of now, do not be in a hurry to switch to a different lender or switch to different home loan plan with the same lender. I believe this is just the start of downtrend of the interest rate cycle.
- Your Home loan EMI has two components, the interest and principal. The interest component is bigger in the initial years, so a small change in the interest rate can have a huge impact. As the loan period progresses, the principal component will increase. So, when the principal becomes bigger, switching to a lower rate has minimal impact.
- You need to consider the loan outstanding, remaining loan tenure, interest differential and other charges before opting for a Home Loan Switch.
- If you have a fixed rate home loans over 13 per cent or so, it would make sense to switch to a floating rate loan.
- If you have not planned for your other Financial goals, it is better to opt for lower EMI and let the tenure remains same. The differential savings can be allotted/invested for your important financial goals. Kindly remember that the bank deposit rates will also come down. So, you have to choose your investment options prudently.
Impact of Rate cuts on Auto Loans & other loans
Unlike home loans – which generally have a floating rate – most auto loans carry a fixed rate. So, existing customers are unlikely to benefit from falling interest rates, but new buyers can benefit from lower rates over five/seven year tenure.
Many other types of loans like personal loans and small-ticket size loans for consumer durables (for bikes, LED TVs, etc.) will come down as banks start reducing base rates.
A 25 basis point rate cut during last week is the turning point in the interest rate cycle. This will surely have an impact on your other investment avenues (like equity, fixed deposits, debt mutual funds etc.,) as well.
RBI governor has cut Repo Rate only and has kept other key policy rates (CRR & SLR) unchanged. As the inflation softens (mostly YES) we can expect RBI to cut other key policy rates too. The rate cuts would put more money in the hands of consumers and help revive investment/the economy. But, the pace of future rate cuts will depend on many factors like inflation, crude oil prices, Rupee Vs Dollar, extent of fiscal deficit etc.,
Latest update (07-June-2017) : RBI keeps Repo rate unchanged at 6.25%, cuts SLR rate by 0.50% to 20% and also keeps Reverse repo rate and CRR unchanged at 6% & 4% respectively.
Latest News (06-April-2017) : RBI hikes Reverse repo rate by 0.25% to 6% and keeps other key rates unchanged.
Latest News (07-December-2016) : RBI keeps the key interest rates unchanged. The latest rates are : CRR @ 4%, Repo rate is @ 6.25% and Reverse repo rate is @ 5.75%.
Latest News (04-October-2016) : RBI cuts Repo Rate by 25 basis points to 6.25%.
Latest News (07-June-2016) : RBI keeps Repo Rate & CRR unchanged at 6.5% and 4% respectively.
Latest News (05-April-2016) : RBI cuts Repo Rate & SLR by 25 basis points. The latest Repo Rate is 6.50% and SLR is 21.25%. CRR is unchanged at 4% . Reverse Repo Rate has been increased by 25 basis points to 6%.
( Image courtesy of Stuart Miles at FreeDigitalPhotos.net)
(You may like reading : “Home Loan – Total Interest & Principal Repayments Calculator“)