Mudra Compass

The Reserve Bank of India (RBI) recently decided to keep the repo rate steady at 6.5% for the 10th consecutive time during its bi-monthly Monetary Policy Committee (MPC) review. This move provides stability for home loan borrowers as it means that interest rates on home loans, as well as Equated Monthly Instalments (EMIs), will remain unchanged for now. By maintaining the status quo, the RBI is aiming to balance inflation control with economic growth, offering relief to borrowers who can continue with their financial plans without disruption.

Why Does the Repo Rate Matter?

Since October 2019, banks have linked most floating-rate retail loans, including home loans, to the repo rate. As a result, any changes in the repo rate directly impact these loans. When the repo rate goes up, so do home loan interest rates, increasing the borrower’s monthly payments and overall interest burden. Conversely, a reduction in the repo rate lowers interest costs and helps borrowers save money.

Inflation and the Repo Rate Outlook

Inflation has been a key factor influencing RBI’s decisions. The Consumer Price Index (CPI) inflation rate remained below the medium-term target of 4% for the second consecutive month, standing at 3.65% in August. Given this trend, the MPC has shifted its stance from “withdrawal of accommodation” to “neutral,” signalling that there may be some room for future rate cuts.

Economists predict that a repo rate reduction could occur starting in December, which would benefit borrowers, especially those with existing home loans.

Impact of Repo Rate Cuts on Home Loan Borrowers

For existing home loan borrowers, a reduction in the repo rate can significantly lower their interest burden. For example, a borrower with a Rs 50 lakh home loan taken two years ago at an 8.65% interest rate would have seen an increase in their interest costs when the repo rate rose by 60 basis points (bps) last year. This raised the effective interest rate to 9.25%, extending the loan tenure by over two years and increasing the total interest payable.

However, if the repo rate is cut by 25 bps over the next few months, starting in December, it could reduce the effective interest rate back to 8.5%, bringing the total interest payable back in line with the original loan terms. This demonstrates how even small repo rate cuts can help offset the impact of previous rate hikes.

Strategies for New Home Loan Borrowers

New borrowers should be mindful of the spreads banks charge on top of the repo rate when choosing a lender. For instance, some banks, such as HDFC Bank, have raised their home loan rates by 40 bps this year, even though the repo rate remained unchanged. This is due to liquidity constraints affecting multiple lenders.

To minimize interest costs, it is advisable for new borrowers to look for home loans with the narrowest possible spread. Even a small difference in the interest rate can lead to substantial savings over the loan tenure.

Prepay to Lower Your Interest Burden

Existing borrowers can reduce their overall interest payments by making partial prepayments on their home loan. Allocating extra funds from savings or an annual bonus towards prepayments directly reduces the outstanding principal, which in turn lowers the interest payable over the remaining loan term. Even modest prepayments can lead to significant long-term savings, making this an effective strategy to ease the financial burden of a home loan.

Consider Switching Lenders

Borrowers who are paying higher interest rates due to older benchmarks like the Marginal Cost of Funds-based Lending Rate (MCLR) or base rate should consider switching to another lender. Many banks are offering home loans starting at 8.35%, providing an opportunity to reduce your interest payments.

Additionally, borrowers can negotiate with their existing lenders to lower their interest rates, especially if they indicate plans to switch. While banks don’t have a formal process for this, Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs) often offer official conversion options, enabling borrowers to move to lower rates for a fee.

Conclusion

The RBI’s decision to keep the repo rate unchanged provides stability for home loan borrowers in the near term. However, those looking to reduce their interest burden should explore options such as partial prepayments, switching to a lender offering a lower interest rate, or negotiating better terms with their current lender. With a possible repo rate cut on the horizon, staying informed and proactive can lead to significant savings on your home loan.