When you buy a home, you pay a down payment first and then take a home loan to pay the remaining amount as the price of the property. Like almost every other individual, you will also take a home loan to buy your house, but have you ever wondered what happens behind the scenes of the home loan process? In case you are a financial expert then you must know everything but as a first time home buyer then you should read further.
Every rule and rate that relates to the home loan process is laid down by RBI or Reserve Bank of India. Based on it the financial institutions such as banks and housing financing companies function. There are several changes made to the process in terms of interest rates, the loan amount, and the tenure of repayment passed on to the banks and HFCs. However, these entities may or may not apply some modifications to these rates. The repo rate has undergone some reductions by RBI, however, the lending rates by banks & HFCs haven’t seen much change.
BPLR (Benchmark Prime Lending Rate): The HFCs are different than the banks in terms of processing the home loan applications. They are regulated by National Housing Bank Limited (NHB), a subsidiary of RBI. The basis of charging rates on home loans is different from what banks follow. The home loans are charged based on an internal benchmark rate also known as Benchmark Prime Lending Rate. All interest rates are calculated with respect to this rate.
The drawback is that there is some haziness working here. As a borrower, you won’t know about the lowest rate that the best customer gets. The lending rates remain unchanged for long as opposed to the frequent changes applied by the banks. Now, when it comes to acquiring new customers, the HFCs offer bigger discounts to them whereas the existing customers are stuck on higher rates unless the PLR is reduced which doesn’t happen oftentimes.
PLR and the Base Rate: On the other hand, banks used a base rate on which the lending rates were calculated. This rate was the limit below which banks were prohibited to lend even to their best customers. Due to this limit, the customers were aware of the lowest interest rate that they can get. It was made so that the rate reductions mandated by RBI could be passed on to the customers allowing them to enjoy lower interest rates. However, it didn’t happen the way it was planned.
As previously thought, the application of base rate was enacted to bring transparency, but the banks implemented their own ideas on this process. Banks allowed very marginal concessions whenever RBI passed down a mandate on the interest rate reductions. This was due to the fact that banks had profiles of old deposits and borrowings which carried higher rates.
The MCLR Policy: As the enactment of a common base rate failed to deliver what was expected, RBI launched its new plan of linking all the loans to their marginal cost of borrowing and for different tenures. Marginal Cost of Funds based Lending Rate (MCLR) ensured that the benefits of the reduced rates and borrowing costs should pass on to the customers quicker. Under this, even with the change in the MCLR of the bank, the interest rates remain unchanged, as the banks were allowed to have a reset period of maximum one year.
Unfortunately, this experiment also failed. Now RBI made it compulsory for the banks to set a benchmark for their loans with respect to a rate that wasn’t calculated internally but to an external rate. So now banks have a choice to benchmark their rates against the following:
RBI Repo Rate
3 months yield by the government’s treasury bills announced by Financial Benchmarks of India Limited (FBIL)
6 months yield by the government’s treasury bills announced by Financial Benchmarks of India Limited (FBIL)
Any benchmark enacted by FBIL
With this, the benefits of any reductions by the RBI will be quickly passed on to the customers.
