Spread your Imagination beyond MCLR


Few days back, the largest lender in India, the State Bank of India(SBI) announced the deep cut in its MCLR.  The MCLR has been reduced to 8 % from 8.90%.  This is the deepest cut that the bank has made in the past one year.  ICICI bank and other banks followed suit announcing the reduction in MCLR.

Its good to know that the interest rates have come down drastically.  It should imply that the cost of funds borrowed will be lower compared to earlier.  The interest rates are dynamic and keep fluctuating.  But, a borrower who is the most affected party of this hardly understands it.  Let me ask you a simple question:  What is MCLR?

Some of you might just copy and paste the word and google it and find end number of webpages opening up and explaining the technicalities.  But, I could hardly find a borrower friendly explanation to the mystery of MCLR!

None of the web links that came up could really make a borrower understand the true significance of the MCLR on their housing loan.  Some of the newspapers and business channels are telling the viewers that they have the best opportunity to buy a new house.  Some are telling the existing buyers to switch to the current MCLR from the erstwhile Base Rate System of Interest rate.  But, converting the Housing loan from Base Rate to MCLR carries a conversion charge.  So, how does it affect them?  Does it make their Housing Loan cheaper ?   These are the questions that every borrower has in his mind.

Let me first tell you how what is MCLR.  MCLR stands for Marginal Cost of Funding Rate.  If you want to know about how it is calculated and why the RBI asked the banks to switch to MCLR, you can just follow the Google Baba and he will guide you through.  I am not the right person to teach you finance and banking.   But, I will tell you how it affects you.

So here you go.  The housing loan interest rate is made up of 2 components: the variable and the constant.  The variable part is called MCLR.  The constant part is called Spread.  The variable part as it states is subject to change.  Banks revise the MCLR according to the monetary policy movements.  RBI decides the monetary policy and the banks toe the line.  But the spread is that part of the interest rate that remains unchanged though out your loan tenure.

Now go back to the news that you read in the newspaper and find out the spread.  The banks have increased their spread.  This implies that the banks are giving you the benefit of the high liquidity in the economy for the time being by reduction in the MCLR. But the spread is high.   For example, SBI has cut down on its MCLR by 90 basis points but the spread is 0.65%.  Prior to the announcement, the spread was lower on home loans.

This basically means that the new loan borrowers who take the benefit of low MCLR and low effective interest rate now may enjoy the benefits for the next one year.  But after one year, the rates will be reset on their home loans.  As a result, there is no guaranty that they would continue to enjoy the benefits.  Everything will depend on the then prevailing market conditions.  High Spread in my opinion is not good in the long term because if the MCLR goes up, the high spread is bound to compound your effective interest rate.


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