As reported in the Economic Times, one of the major financial institutions announced that their short-term loans and large deposits amounting over Rs. 1 Lakh are to be linked to repo rate. Consequently, a high amount of loans and deposits made below Rs. 1 Lakh will continue to be MCLR based so that individuals and retailers stay protected from abrupt market fluctuations.

What is the repo rate?

Just like individuals, financial institutions and NBFCs may experience a shortfall of finances and seek loans. In this case, they seek funds from the central bank, i.e. Reserve Bank of India.

Repo rate refers to the rate at which these commercial financial institutions borrow finances from the RBI.

What is MCLR?

The Marginal Cost of Funds based Lending Rate (MCLR full form) is the minimum rate that a financial institution must charge while lending finances to individuals or business units. This rate is decided to bring transparency in the financial system apart from maintaining a proper balance of finance between lending institutions and borrowers.

Presence of MCLR rate ensures that loans are offered to every individual in somewhat the same interest rate apart from certain exceptions without incurring any monetary loss to lenders.

Absence of MCLR in early times created scenarios where specific privileged customers used to avail loans in base rate while some had to pay high interest rates. This imbalance, along with losses to commercial financial companies, were eliminated with the introduction of MCLR.

How MCLR affects loans?

Long-term floating loans like home loan is directly linked to MCLR meaning that they have impact over the loan in case there is a change in the repo rate. So, at times when RBI decides to increase its repo rate, there will be an increase in MCLR rate as well in accordance with it.

As a result, the interest levied on loans are going to be affected as well. However, it is to note that the effect of MCLR on loans is valid only for floating rates of interest and not for a fixed interest rate.

Consequently, it is important that you know everything about MCLR based home loans before you plan to apply for one. Further, look at the below-mentioned effects of MCLR –

• For existing loan borrowers

The impact of changes in MCLR for existing loan borrowers seems to be nominal for the time being; the change isn’t reflected until the tenor of this rate is reached. Meaning, there is no change in the interest rate unless you have completed the 6-month or 1-year MCLR tenor.

The new rate will be in effect only when this tenor is reset. So, individuals immediately can’t avail the benefits or losses caused by fluctuation in MCLR. Also, individuals facing difficulty in paying EMIs for their housing loan and planning for home loan balance transfer must know the MCLR first before application.

• For new loan borrowers

New borrowers are likely to be benefitted in case there is a change in the MCLR. Individuals may avail loans with lowered rate of interests.

Subsequently, it becomes essential to study over MCLR and its effects on Loans so that one can determine a best-case scenario for them. Some financial institutions even offer loans on MCLR without the spread making it much more affordable for individuals.

It should be noted here that NBFCs do not provide floating rate home loans based on the MCLR. Hence, loans offered by them may be comparatively affordable.

Since MCLR brings a transparent financial system in the forefront to process loan applications and small deposits, the commercial lenders are continuing offering finances that are based on this rate. The rate hence is in the best interest of the borrower as well as the lender.

The Reserve Bank of India has implemented the MCLR so that no partial monetary benefits can be acquired either by financial institutions or any borrower.