How are Home Loan interest rates determined in India

Home loans are quite popular in India as they allow middle-class individuals to build their own homes easily. The loans have high repayment tenures and low home loan interest rates which allow the loans to be repaid affordably. Moreover, there are different types of loans available for different housing needs of individuals.

 When it comes to the interest rate, there are different types of loans. Fixed interest loans are those home loans whose interest rates remain fixed throughout the loan repayment tenure. Then there are floating rate home loans where the interest rates changes with a change in the interest rates in the market. Whatever be the type of interest rate, many borrowers do not know how the home loan interest rates are calculated and fixed. Though you know that the lender decides the home loan interest rate, do you know who how it is determined?

Home loan interest rates are calculated based on the following rates –

Repo rate           

Repo rate is the rate of interest which the Reserve Bank of India (RBI) charges from banks on the amount it lends. When banks borrow from RBI, the interest applicable on such borrowing is called repo rate. If RBI increases the repo rate it becomes expensive for banks to borrow and banks, consequently, increase their lending rate to compensate for the increased repo rate. Thus, any changes in the repo rate directly affect the home loan interest rate.

MCLR

MCLR stands for Marginal Cost of Fund Based Lending Rate. MCLR is a floating rate of interest which depends on the marginal cost of funds, negative carry on account of Cash Reserve Ratio (CRR), tenure, operating cost and premium. Loans are, nowadays, calculated on the MCLR rate of interest. Using the principle of MCLR, five benchmark interest rates on loans are set for five different time periods – (overnight, one month, one quarter, half-year and a year). Using these benchmarks, the MCLR is calculated. If the MCLR changes, home loan interest rates would also change.

Reverse repo rate

Reverse repo rate is the rate of interest at which the Reserve Bank of India (RBI) borrows from banks. If the reverse repo rate would increase, banks would be tempted to deposit money with the RBI to earn higher interest. This would cause a reduction in the supply of loan as banks would have lower funds available for lending. When the supply of loan is reduced, the loan interest rates would become higher. Thus, the reverse repo rate has a direct effect on home loan interest rates. A rise in the reverse repo rate would increase the home loan interest rate and vice versa.

Cash Reserve Ratio (CRR)

CRR is the amount of reserve which banks maintain with the RBI and is comprised of the deposits available with the bank. The CRR determines the amount of money banks would have at their disposal for lending. If CRR is increased, banks would have to maintain a higher reserve with RBI thus lowering the loan supply. As such, an increase in CRR would increase home loan interest rates too.

These factors determine home loan interest rates in India and you should know about them before you avail a home loan for yourself.