A Complete Guide to Understanding MCLR

As per a February 2020 report, the personal loan segment experienced remarkable growth in India, thanks to the high demand for home loans. At that time, the home loan portfolio was sitting at around Rs.13 lakh crore. While it depicts and increased popularity of these credit options even during trying times, individuals planning to avail housing credit in the future should consider the various factors which can affect their repayment capacity and liability.

MCLR rate is one such integral factor which one should know before availing a home loan. It is especially true if you opt for such credit under floating rates.

What is MCLR?

Marginal Cost of Funds based Lending Rate (MCLR full form) is the minimum rate at which a financial institution can extend housing loans. It was implemented in 2016, replacing the older base rate system. It is a form of an internal benchmarking system used by lenders to determine the interest rates on their secured and unsecured credit options.

The MCLR rate relies heavily on the key policy rate at which the Reserve Bank of India lends money to all the NBFCs operating within India, also known as repo rate. Therefore, any change in this repo rate can also enforce a change to the set MCLR, for various loans and advances, such as the MCLR home loan interest rates. Specifically, if the RBI hikes rates, you can expect your home loan interest to increase and vice versa.

However, this is not all you need to know about MCLR based home loans. One would also need to understand several other aspects to appreciate how this rate can affect his/her loan repayment.

Factors affecting MCLR calculation

Financial institutions consider several factors to arrive at the MCLR rate. The four broad considerations for this calculation are as follows – 

  • The marginal cost of funds

NBFCs consider the rate at which deposits of a similar quantum and maturity were raised before the review period. From this, financial institutions can determine various components, including the Marginal Cost of Borrowing and Return on Net Worth. The former holds 92% weightage, while the latter accounts for just 8% of such calculation. 

  • Tenure premiums

MCLR rate determination of lenders is typically reliant on loan tenures. As home loans are long-term advances, their tenure further bears a critical weightage in tenure premium determination. 

Longer repayment periods thus draw increased interest and vice versa. Thus, if you opt for such advances, ensure you choose limited tenures to restrict interest payments. Doing so will help you understand MCLR and its effects on loan. 

  • Negative carry due to Cash Reserve Ratio

Negative carry on Cash Reserve Ratio arises when the cost of raising funds is more than the returns from them, thus leading lenders to consider it for MCLR determination.  

  • Operating cost

Your current MCLR rate relies on the operating costs as well, which refer to the expenses for recovering overhead costs, besides the service charge, which is recovered separately.

Benefits of MCLR

Opting for home loans at a marginal cost of lending rate has several benefits for the borrower. These include – 

  • Increased transparency – MCLR is an internal benchmarking system, whereby borrowers are always apprised of how financial institutions decide interest rates on home loans.
  • Reduction in interest rates – Individuals opting for a floating rate home loan can benefit when the RBI slashes its repo rate. It would cause lenders to adjust their home loan rates as well, which can lower the lending rates and well as the EMIs for existing borrowers.

However, one must also understand that if RBI hikes the repo rate, the interest rate for MCLR-based home loans will increase too. One must consider carefully whether he/she is comfortable with such risks associated with floating credits.

A comparison of external and internal benchmarking system

In 2019, the Reserve Bank of India implemented an external benchmarking system for retail loans. Such a system offers increased transparency when it comes to changes in interest rates and is better known as RLLR or Repo Linked Lending Rate based financing. 

Individuals opting for loans under this new system will experience a faster transition of rates after repo rate changes. While this is beneficial when repo rate decreases, faster transitions also mean you would need to service higher EMIs sooner in case of interest rate hikes.

One should thus look forward to renowned lenders offering better rates to reduce the hassles and an overall financial burden. 

Read Also: A Complete Guide to Understanding MCLR

Additionally, you must look for a HFC which provides pre-approved offers to expedite the credit availing procedure. These offers are available on a range of loan options, such as home loans, loans against property, and others. You can check your pre-approved offer by submitting details like your full name and phone number.

If you do not intend to avail a fixed interest loan, consider the current RLLR or MCLR rate based lending. Floating interest credit under this system can yield substantial benefits to the borrower. In some cases, it may even allow you to lower the total debt by reducing interest liabilities considerably.


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