Repo linked loans are essentially loans where the rate of interest charged is linked directly to the Reserve Bank of India’s repo rate. According to a recent RBI policy, all retail loans, such as housing loans and car loans, need to adhere to external benchmarks set by this governing bank. Repo rate is also known as the repo-linked lending rate or RLLR.
Therefore, if you are opting for a home loan as of October 2019, you should understand a few factors of repo-linked loans to get the best deals. The RLLR will directly influence your home loan EMI, which is why you need to know more about it.
How do financing companies determine the benchmark?
According to this new RBI directive, HFCs are free to choose their benchmark rates from the following options.
- Reserve Bank of India’s repo rate.
- Three or six months Treasury Bills.
- Any other benchmark rates that Financial Benchmarks India Pvt. Ltd declares valid.
In most cases, lending institutions in India have opted for RBI’s repo rate as their benchmark when it comes to home loans.
Considering your lender’s benchmark is important because some benchmark rates are more volatile than others. Frequent fluctuations in this benchmark can also have a similar effect on your housing loan installments. For instance, those HFCs adhering to a T-Bill benchmark face more volatility. Therefore, home loans from such institutions are more suitable for people with a high income.
Reset period and its effect on home loans
Every financial institution resets its home loan interest rate after regular intervals. After this reset, a new rate of interest for the loan comes into effect. Previously, the common reset period was once a year. Due to the adherence to external benchmarks today, HFCs must reset their rates at least once in 3 months.
Lenders have adopted 3-month reset periods because the RBI repo rates are revised quarterly and not annually. Understanding and learning the reset period your lender follows is important as it helps you to calculate the EMIs for your home loan.
What is the spread?
Spread is an additional rate of interest the financing company charges on top of the benchmark rate. HFCs are free to decide the spread they want to charge at the time of housing loan application as the final interest rate you are liable to pay. Therefore, the total interest rate for such loans is the sum of the benchmark rate and the spread.
If you want to lower your home loan rate of interest, make sure to compare the various rates on offer from the different lenders in the market. Pick the credit option that charges the minimum interest on the borrowed sum.
Credit score and its effect on housing loan spread
At the time of loan approval, lenders decide on the spread rate depending on two crucial factors.
- The operating cost for the loan.
- The credit profile of the borrower.
According to the RBI rules, HFCs can change the spread based on operating cost fluctuations. However, they can do so only once every 3 years. However, this spread can also change if there is a drastic fluctuation in the borrower’s credit scores.
While previously you needed to maintain a pristine credit rating before loan approval, now you must maintain proper credit rating during the entire loan tenor. Significant drops in this rating during the tenor can cause increased spread, thereby, increasing your interest and EMI burden for the said loan.
Credit scores have always been a crucial factor for housing loan eligibility. With repo-linked loans, the importance of your credit score is even more so crucial.
To ensure the best rates, choose a reputed lender who offers attractive borrower-friendly features other than just affordable interest rates.
Research the repo-linked loans to understand how the recent change in guidelines can affect your home loan plans.