The RBI introduced the MCLR method in 2016 to replace the base rate system initiated in 2010. MCLR means the Marginal Cost of Funds-based Lending Rate. It is the lowest interest rate at which a financial institution can lend a home loan. The financial institution reviews it for the borrowers during the annual reset date of the MCLR rate, where the duration can be 12, 6 or 3 months. As per the changes in this rate, the interest rate on a house loan is calculated and charged. Here is everything you need to know about MCLR and how it influences home loan interest rates.
RBI Guidelines About MCLR
It does not affect home loans available at fixed interest rates.
Deposit balances and other borrowings are taken into consideration when the marginal cost of funds are computed.
Financial institutions, such as banks must publish the MCLR for different tenures.
This rate will remain the same from the date at which a home loan at floating interest rates is sanctioned to the next reset date.
How is MCLR Calculated?
This rate is calculated according to the tenure of the loan. Such a tenure-linked benchmark is, therefore, internal. The financial institutions decide the actual lending rates after adding the components spread to this. After that, they publish their MCLR rates followed by thorough inspection.
The 4 important factors depending on which the MCLR is fixed are:
1. Tenure premium: The cost of lending differs based on the loan tenure. The higher the tenure, the greater will be the risk. The financial institution covers this risk by transferring the load to the borrowers. So, it charges an amount in terms of a premium, which is called the Tenure Premium.
2. The marginal cost of funds: This is the average rate at which deposits with similar maturities were raised for a particular duration before the review date. This cost is mentioned in the lender’s books in the form of outstanding balances. The MCLR has many elements, such as the marginal cost of borrowings and the return on net worth. The return on net worth takes up only 8% while the marginal cost of borrowings accounts for 92% of the rate. This 8% justifies the risk of weighted assets as indicated by the Tier I capital for banks.
3. Operating cost: A financial institution incurs different expenses to raise funds, open branches, pay salaries and other factors. All operating costs related to offering loan products are included in the total costs. Only the cost of offering services recovered in the form of service charges are excluded.
4. Negative carry on account of Cash Reserve Ratio (CRR): It happens in the case of zero returns on the CRR balance. This, in turn, affects the mandatory Statutory Liquidity Ratio Balance reserve held by all commercial banks. It is accounted negatively because the lenders are unable to utilise the funds to gain any interest or earn income.
Before you apply for a home loan with a floating interest rate, consider learning how the interest rate is influenced by the MCLR.