Repo, Reverse Repo Rate and Its Impact on Home Loans

Repo rate is a financial concept related to financial institutions and their legal obligations towards the Reserve Bank of India. Be it a bank or a non-banking financial company, all lending institutions have to pay interest to the RBI under the Government of India for letting them borrow money for their operations. This rate is fixed for a certain tenure, but according to the current economic situations like inflation or recession of the country, the RBI can change it uniformly for all lending institutions.

All lending institutions base their personal and home loan rates upon this repo rate. The repo rate change effect on home loans becomes evident while considering interest rates and additional charges. Read on to know more about it.

What Is Repo Rate For Home Loans?

The term “Repo Rate” is a short way of saying Repurchase Option. Its working is simple. To be able to give out funds, a lending institution requires an initial lump sum amount. It gets this amount from the RBI at an interest rate. Another circumstance under which it needs to borrow money from the central bank is when it falls short of liquid funds to dish out.

The home loan repo rate currently stands at 6.25%. In fact, the repo rate linked to home loans was updated on 7th December 2022 by the RBI to keep up with the inflation.. Repo rate increases and decreases with inflation, however with different rates.

There is one major reason that the RBI spikes up the repo rate, i.e. to help regulate lending practices across the country. When inflation rises, the RBI bumps up the interest rate that lending institutions face. As a result, these firms hesitate in borrowing funds, causing a further dip in borrowing at the customers’ end. Overall liquidity drops and inflation finds a coolant.

For home loans, the repo rate increase effect can be observed almost immediately across lending firms. Lending firms need to up their interest rates by a certain fraction so that they can continue running their business in stability. The effect of repo rate on home loan interest is evident when you compare the rates before and after the month of December 2022.

What is Reverse Repo Rate?

A functional financial system is safe and stable when the overall liquidity that it runs on is kept nominal. This is the objective of the central regulatory body, the RBI. To prevent an overshoot in liquidity of cash in the economy, the RBI has put in place reverse repo rates.

A reverse repo rate is the interest that the RBI gives to lending firms when it borrows funds from them. It is the reverse of a repo rate. However, this value isn’t the same as repo rate. Currently, the reverse home loan repo rate is at 3.35%. It is kept lower than the repo rate since it is only a tool that maintains cash flow in the system.

What is The Difference Between Repo Rate And Reverse Repo Rate?

These two rates differ by the following factors:

• Meaning- The repo rate is the rate at which the RBI grants loans to lending institutions in order to meet a shortfall in funds and control inflation. The rate at which lending institutions grant loans to the RBI to control the money supply in the economy is called the reverse repo rate.
• Rate: The current repo rate for home loan is 5.9%, while the reverse repo rate is at 3.35%.
• Bodies Involved: The repo rate is given by the lending institution to the RBI, while the reverse repo rate is given by the RBI to the lending institution.
• Reasons: Repo rate is levied when banks or NBFCs require liquid funds, while reverse repo rate is levied to discourage high liquidity.
• Working Backbone: Repo rate is based on repurchase agreements, while reverse repo rates are based on reverse repurchase agreements.

How Does Change In Repo Rate Affect Home Loans?

When the repo rate changes, banks or NBFCs have to bear higher costs of borrowing from the RBI. A lower repo rate translates into lower EMIs for the borrowers. Likewise, when the repo rate is increased, it directly impacts the home loan interest rates. Since lenders are paying high interest rates themselves to acquire the necessary funds and manage their own revenue, this in turn forces lenders to increase their home loan lending rates by a certain degree. They adjust processing fees, closure costs, and service charges to help them combat the expense. However, this change in percentage is relatively low compared to the change in repo rate.

Conclusion

Despite changes in repo rate, home loans are always going to be great options for you to consider for financial support.

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