Is your big-ticket home loan pinching you in this time of crisis? While continuing to pay your EMIs is advisable (rather than opting for the moratorium), it may be time to review your existing home loan to see if you can lower your monthly payout.

In its monetary policy last week, the Reserve Bank of India (RBI) held its key policy repo rate at 4 per cent.

But that doesn’t matter.

A look at data across banks suggests that even now there is a wide difference between the lending rates on home loans linked to MCLR (marginal cost of funds-based lending rate) and that on those benchmarked against RBI’s repo rate.

In many cases, the difference is 30-50 bps within the same bank, which amounts to a sizeable difference in interest over the tenure of the home loan.

Basics

Home loans are broadly of two types — fixed and floating. Generally, fixed-rate home loans charge a substantially higher interest rate. Hence, it may be advisable to opt for floating-rate loans, particularly in a falling-rate scenario.

Now, under floating-rate loans, lending rates change depending on the interest-rate movements in the broader economy. Earlier (from April 2016), home loans were linked to a bank-specific benchmark — MCLR.

Here, while a repo-rate cut by the RBI leads to banks lowering their MCLR, it happens with a lag and varies widely across banks.

Also, generally, home loans are benchmarked against one-year MCLR and, hence, lending rates are reset only once every year. So, even when banks cut MCLR, the benefit of it is transmitted to borrowers only when the loans are reset.

To address these issues, the RBI had mandated banks to introduce repo-linked loans from October last year. Here, if the RBI cuts the repo rate, it gets reflected on your lending rates much faster (banks have to reset their repo-based benchmark rates at least once in three months).

This is a key reason why lending rates on repo-linked home loans are much cheaper than those on MCLR-linked loans within your own bank.

Effective rates matter

While comparing rates, the final effective lending rate is what matters and not the repo-linked benchmark. This is because banks charge a spread over the repo-linked benchmark rate to arrive at the final loan rate. For instance, at SBI, the repo-linked benchmark rate (EBR) is currently at 6.65 per cent.

For a ₹30-75-lakh loan, a spread of 60 bps (for salaried borrower) is charged on it, taking the effective lending rate to 7.25 per cent. At ICICI Bank, the repo-linked rate is currently 4 per cent, over which the bank charges a 3.2 per cent spread, taking the effective lending rate to 7.2 per cent.

Hence, while comparing rates to switch, you need to look at the final loan rate, including the spread, under both repo- and MCLR-linked loans.

Next, some banks also offer special rates for good borrowers with sound credit scores. For instance, at PNB, while the spread charged over the benchmark is 50 bps in case of a borrower with credit score of 750 and above, it is higher at 75-85 bps for those with a lower score. In the case of Bank of India, you can get loan at an attractive 6.85 per cent if you have a high credit score.

Once you have noted the underlying benchmark, the spread and the concession (if any), that determine the final lending rate, the next step is to do the maths.

Tidy savings?

Your decision to switch will broadly depend on three factors — difference in lending rates, remaining tenure of loan and outstanding loan amount.

Your savings by way of interest on the entire tenure (residual) of the loan will be the highest when all three are on the upper side — a wide difference between existing and new lending rates (under repo-linked), long residual tenure of loan and huge outstanding loan amount.

The accompanying table shows that if you have a home loan outstanding of ₹55 lakh and the remaining tenure is 23 years, sizeable savings kick in when the difference in lending rates is 50 bps (or over).

In such a case, you can straightaway make the move. But if the difference in lending rates is only 10 bps, the savings shrink substantially to about ₹1 lakh over the tenure of the loan.

While this is still notable, you may still want to weigh other charges before making the switch. For instance, if you are making the switch within the same bank, you may have to pay a one-time administrative fee.

For example, Bank of India charges an additional 0.10 per cent over normal lending rate if you intend to switch over from MCLR- to repo-linked loans, according to the bank’s website.

In case you are switching between banks, there may be a processing fee involved, which could be a percentage of loan amount (can go up to 2 per cent, subject to a minimum amount). Also, amid the ongoing restrictions owing to the Covid-19 pandemic, switching between banks may be procedurally tedious.

In any case, if you have a small loan outstanding and a short tenure remaining, it may not make sense for you to switch, even if the lending rates are widely different (see table). For instance, in the case of a ₹5-lakh outstanding amount with a residual tenure of four years, the savings will be quite low.

The other factor to take into account is that given that rates have fallen sharply over the past two years, a rate hike in the next two years could pinch you more under the repo-linked loans.

This is because lending rates can move up sharply and quickly. That is all the more reason for you to avoid making the switch if you have a short tenure of loan left.