The Reserve Bank of India (RBI) declared a 50 basis point (0.5 percent) cut in its policy interest rates – repo and reverse repo rates – in the annual credit policy for this financial year. During its last quarter monetary policy review, the RBI indicated a monetary policy softening based on the state of economic growth and rate of inflation.
Although the inflation rate has not come down as yet to the comfort levels, the RBI has softened its monetary policy mainly to address the concerns of the slowdown in the economic growth rate. Analysts feel a further softening in the monetary policy depends on factors such as the inflation rate as well as growth in the current financial year.
The repo rate is the short-term lending rate on which the RBI extends short-term lending to banks. A lowering in the repo rate lowers the cost of funds for banks and hence there are expectations that lending rates on loan products will come down in the near term. As in the past, the interest rate on new loans may come down more sharply and swiftly than on existing loans. This happens mainly because new accounts are fresh sales and hence banks float many promotional schemes to market them. A rate cut happens on existing loans only when the banks get comfortable on their overall costs of funds and maintain their net interest margins. On the other hand, since borrowing from the RBI becomes cheaper, interest rates on deposits will also see a downward trend in the short to medium terms loans.
Impact on Borrowers
Most banks have not reduced their lending interest rates on existing home loan accounts following the recent cash reserve ratio (CRR) cut announced by the RBI last month. However, the current 50 basis points repo rate cut will bring down the cost of funds significantly for banks leading to lower interest rates on existing home loan accounts too shortly.
Many banks do not automatically reduce the rates but offer schemes to borrowers to migrate to lower interest rates. Borrowers should therefore track such promotional schemes coming up from their bank to avail of lower interest rates on their existing loan schemes.
Impact on New Loans
Banks have already started going aggressive on their new home loan schemes since the cut in the CRR last month, which resulted in more liquidity with banks. The repo rate cut will further add to the pressures on banks to come up with promotional schemes and offer attractive interest rates to push new loan products. Those looking at fresh home loans should scout for bargains on the rate of interest, upfront processing fee and other fees while proc essing the application. Since the RBI has given indications that further policy softening may not happen in the near term, it is a good time for those waiting for rate cuts to process their home loan applications.
Choosing Loan Scheme
There are two types of loan schemes – fixed interest rate schemes where the interest rate remains fixed for some time and the floating interest rate schemes where the interest rate keeps fluctuating based on market conditions. Since the interest rates are expected to come down further for short to medium terms, borrowers should go for the floating interest rate scheme.
Also, it will be wise to analyse the available options and go for a scheme that offers part fixed and part floating rate or fixed rate which provides an option to lockin at a lower rate in future by paying a conversion fee to the bank.