Rate Cuts by RBI! Should Home Loan Takers be Happy?
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Reserve Bank of India has slashed its repo rate once again. The timing has been perfect as this falls in the festive season. On 4th of October, the rate was reduced by 25 basis points from 6.5% to 6.25% with immediate effect. After reduction, the prevailing rate stands at its lowest level in 6 years but the big question here is, ‘should you rejoice’?

If the banks pass the benefit they have received from RBI, the biggest beneficiaries can turn out to be the borrowers of home loans. The average interest rate charged on home loans currently lies somewhere around 9.5% p.a. If banks transfer full benefit to the lenders, then the interest can come down to 9.25% p.a. Since home loans involve huge amount and long tenure, the cumulative effect can be dramatic.

To understand better, suppose Mr. Raman has taken a home loan of Rs. 50 lakh at 9.5% p.a. for a period of 20 years. His EMI at this rate will be Rs. 46,606 p.m. However, if his lender bank reduces the rate by 0.25%, then his EMI will reduce by Rs. 812 p.m. Generally it is witnessed that instead of reducing the size of EMI, banks reduce the tenure of the loan to let the borrower gain the benefit of interest reduction. The following table will help you understand how much benefit will Mr. Raman get depending upon the time already elapsed.

 Time before completion of tenure Reduction in no. of EMIs 5 years 1 EMI 10 years 2 EMIs 15 years 5 EMIs 20 years 12 EMIs

As you can infer from the table above, if Mr. Raman is about to start the payment then he will get maximum benefit as the bank will reduce 12 EMIs from his loan. If only 5 years are remaining for the completion of his loan tenure then also he can benefit from 1 EMI reduction from the remaining EMIs. So the financial benefits are significant if banks pass the whole benefit of interest reduction to the borrower.

However, expecting a reduction of 0.25% immediately in the lending rates will not be right. If we look at the recent events, we can see that despite repo rate being continuously slashed by the RBI, banks have been reluctant in cutting down their interest rates on loans. Between January 2015 and March 2016, RBI slashed repo rate several times to bring it down by 125 basis points, but public sector banks and private sector banks reduced their rates by 55 basis points and 50 basis points respectively. Banks have blamed a sluggish deposit growth behind their inability to reduce lending rates. Another big factor behind this is the rise of NPAs (bad loans) which has further strained the financial situation of banks. So, it may not be right for borrowers to expect much in the short run but given some time, the new regime can eventually give some relief to them.