What is MCLR? Here’s Everything you Need to Know
MCLR or Marginal Cost of Funds Based Lending Rate is one of the internal reference systems that Indian financial institutions use to determine interest rates on various retail loans. Since MCLR rates represent an internal benchmark system, lenders can implement interest rate changes through it whenever they feel the need to do so.
With the introduction of RLLR or Repo Rate Linked Lending Rate, this internal benchmarking has been planned to be phased out over time. Nevertheless, as many lenders still charge interest at MCLR-based rates for continuing loans, knowing what is MCLR rate can be beneficial. Here’s a look.
What is MCLR?
The MCLR system was introduced in 2016, replacing the earlier base rate system of lending. The primary function of this system, implemented by the Reserve Bank of India, was to determine interest rates for consumer loans. One can thus say that an MCLR rate is the lowest interest rate at which a financial institution can lend to its customers.
Apart from the interest rate on a term loan, MCLR also relies on the loan tenure, operating cost, and negative carry because of Cash Reserve Ratio (CRR) implication. Learning how these factors affect the MCLR rates is integral in understanding how this system functions.
Factors affecting MCLR
In a bid to learn all you need to know about MCLR-based home loans, you must study how each factor plays an integral part in the calculation of MCLR.
- Tenure premium
Home loans with extended repayment tenures are riskier from the perspective of a lender. To offset this added risk, HFCs often shift the burden to the borrower in the form of an additional premium, known as tenure premium. The tenure premium of a loan is considered when determining the MCLR-based rates for this credit.
- Cost of raising funds
Lenders need to consider the expenses related to raising funds, which they provide as loans. These expenses are taken into account before calculation and adjusted into the final home loan interest rates.
- Negative carry on CRR
Negative carry on the Cash Reserve Ratio is affected when returns from a loan are less than the cost of the funds.
Formula for calculating MCLR
Now that you know what is MCLR and its various considerations, take a look at the formula for deriving this rate.
1-Year MCLR on a Home Loan = Interest Rate Offered by Financial Institution + Tenure Premium + Negative Carry on CRR + Cost of Raising Funds
Every lender determines MCLR for different loan tenures, which can range from 3 months to 6 months. Nevertheless, the final interest rate on your MCLR-linked loan is decided by adding a spread to the MCLR. This spread relies on several borrower factors, such as credit score, loan principal amount, tenure and more.
Now that you know all about MCLR and its effect on your home loan interest rate, you should also devote some time to understanding repo rates.
Repo rate and its importance
While MCLR rates refer to the internal reference system followed by Indian financial institutions, the repo rate is one of the external benchmarking systems. The Reserve Bank of India sets the repo rate, based on which HFCs adjust their RLLR on home loans.
If you opt for an RLLR-based loan, interest rate on this credit will fluctuate based on any change in the repo rate. If the RBI slashes such rates in a particular period, associated RLLR loan rates also witness a decline. Repo rate-linked loans often result in greater savings when compared to MCLR loans. This happens primarily because of the following factors –
- The change in interest rate on loans following the repo rate benchmark is much faster when compared to MCLR-based loans. For instance, if RBI cuts the repo rate, RLLR-based borrowers will be the first to experience the benefits of this rate slash. MCLR-based credit borrowers, on the other hand, will keep paying the same EMIs for a long time before changes come into effect.
- Since RLLR loans refer to an external benchmark, any interest rate changes during home loan tenure are more transparent. Customers can easily look up to repo rate cuts or hikes, which lead to a change in their home loan interest rate midway.
If transparency is a concern, availing home loans from reputed financial companies can help. These lenders provide impeccable quality of service, assisting borrowers in gauging their liabilities with ease while ensuring transparency in loan charges.
The financial institutions also simplify loan applications, while ensuring speedy approvals with their pre-approved offers. These offers are available on a range of credit options, including home loans and loans against property. You can check your pre-approved offer by submitting contact information and your full name.
Extensive knowledge about RLLR and MCLR rates should help in picking a suitable form of credit when buying a new property. One should also read the fine print in loan documents to check for any additional information about essential terms of the loan, and decide accordingly.