For better transmission of key monetary policy rates to end borrowers, the RBI with effect from October 1, 2019 has asked lender to link their floating rate loans i.e. retail as well as MSME loan to some external benchmarking rate. Until previously, the banks pegged interest on their loans to MCLR or marginal cost of funds based lending rate. And while many banks have chosen the RBI’s repo rate i.e. the rate at which Rbi lends money to commercial banks as their benchmark, individual bank’s home loan rate and other conditions vary. So, here is how you should select the best home loan option for you:
It is to be highlighted that when compared to public sector banks, private sector banks including the likes of Axis and ICICI Bank have fixed the spread i.e charged over and above the repo rate of almost 350 basis points, which renders their home loan option.
Nonetheless other than interest rate, you need to consider the following procedure while zeroing in on the best home loan option for you after the external benchmarking rule:
How to choose the best home loan
1. When the external benchmark remains repo rate, it will be difficult to decide and for you to understand why most banks have adopted this mechanism is because the repo rate will be less volatile in comparison to other available options such as the 3 or 6-month treasury bills or any other benchmark market interest rate published by the FBIL as an external benchmark.
2. Now experts during such a scenario have asked to put focus on spread which is decided by banks and borrowers should choose for a home loan option in which the spread range is narrow over the repo rate as it will then provide true reflection of the external benchmark rate.
3. Credit risk premium is another factor which needs consideration and while some banks had been transparent on this, few others like Axis Bank has not specified it in a specific way. In case of this attribute, while some of the banks have right away suggested that CIBIL score will be made the basis for deciding on the credit risk premium that will be charged. While few others like the ICICI Bank said that it will give weightage to ‘bureau score’. So, for you to get an advantage with good credit score, you should be having a score of 750 or more.
4. So, as the benefit will be immediately felt by borrowers with repo rate as the external benchmark as reset will be made every 3 months (in case of falling interest rate). Notably the operating cost which makes up the spread will be changed every 3 years. But the credit risk premium can be changed in case the customer’s credit profile changes tremendously. If the differential in interest rates of your existing home loan option and the repo linked loan is atleast 35 basis point, you should switch to the new regime. Also, you should go for the home loan option in whose case the interest rate is more transparently linked to your credit score.