Home Loan Borrowers Should Track Repo Rate Movements

In its June 2012 mid-quarter monetary policy review, the Reserve Bank of India (RBI) kept its policy repo rate unchanged at eight percent and the reverse repo rate was also left unchanged at seven percent. There was lot of excitement around the event with many analysts expecting a rate cut.
This buzz about a rate cut on key interest rates happens every quarter. The impact of a change in interest rates is easy to understand. But the impact of a change in the repo rate is a bit confusing. Is there any direct correlation between changes brought in by the RBI and the rate changes at the retail level? Does it really impact home loan rates? Yes, is does. The interest rate for the borrower will be change in repo rate plus the rate of interest on which he availed the loan from the bank. So, if the repo rate increases the interest rate on the loan will also increase, thereby increasing the EMIs.
The repo rate as it is popularly known, or the repurchase rate as it is technically called is essentially the rate at which the RBI lends money to commercial banks. This is the rate at which banks can access funds from the RBI in case they need them. If the RBI hikes its repo rate, it becomes costly for banks to borrow money from the RBI so they in turn hike the rates at which customers borrow money from them to compensate for the hike in the repo rate. If the repo rate is low the cost of borrowing money for a bank will be lower. If the cost of funds is low then the commercial banks are in a position to pass on the benefit of the lower cost of borrowing to their customers. This benefit can be passed on in two ways. Either by lowering the rates that banks charge or pay more on deposits they take from customers.
A borrower of funds is called a seller of the repo and a lender of funds is called a buyer of the repo. When the term of the loan is for one day it is known as an overnight repo. The RBI uses this rate to lend to banks so that they can meet their day-to-day requirements and this is lent against an approved list of dated government securities. These are then repurchased from the bank after a pre-fixed number of days as directed by the RBI. Hence, the name of the charge is repurchase or repo rate.
Being the banker to the nation, the RBI technically has an unlimited capacity to lend and borrow in local currency – the rupee. Hence, the repo and reverse repo rates act as a ceiling and a floor for the interest rates in the country. If the central bank wants to put more money into circulation, it will lower the repo rate.
The reverse repo rate is the interest rate that banks receive if they deposit money with the central bank. The reverse repo rate is always lower than the repo rate. Increases or decreases in the repo and reverse repo rates have an effect on the interest rate on banking products such as loans, mortgages and savings.
Banks offer loans such as home loans and auto loans at an interest rate which is directly proportional to the repo rate. If there is an increase of 0.25 percent in the repo rate, this increase will in normal circumstances be directly passed on to the borrowers. Taking an example, a home loan borrower with a home loan of Rs 30 lakhs borrowed at an interest rate of 10 percent and having tenure of 15 years will have an EMI of Rs 32,238. With an increase of 0.25 percent in the borrowing rate the EMI will rise to Rs 32,698 reflecting the direct impact of increase in the repo rate and cost of borrowing.
Hence, all home loan borrowers should track the monetary policy closely for announcements from the RBI as they have a major impact on their home loan borrowings.


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