What Is the Repo Rate? How Does It Impact Your Home Loan and LAP?

What is repo rate?

The rate, at which commercial banks borrow money from the Reserve Bank of India (RBI), the Central Bank of our country, is known as the repo rate. Commercial banks borrow money because of statutory measures, shortage of funds or to maintain liquidity.

The RBI uses the current repo rate as one of its main tools to control inflation.

During inflation, the RBI increases the repo rate. This discourages commercial banks from borrowing from the central bank. This, in turn, reduces the money supply within the economy and helps to check inflation.

When inflation decreases, RBI takes the opposite stance. Repo and the reverse repo rates are components of the liquidity adjustment facility.

Why is the RBI repo rate important?

As discussed above, the RBI increases or decreases the repo rate as per inflation in the country. It is a mechanism or tool through which the central bank keeps inflation within limits and controls the economy.

The central bank lends the money for a short term. Banks can borrow the money for a maximum period of overnight after which they buy back their deposited securities at a previously agreed-upon price.

The RBI accepts securities or collaterals in the form of bonds, gold, etc. The primary reason why banks borrow money from the central bank is to maintain cash reserves or liquidity as a precautionary measure.

What is a home loan?

A lender gives a home loan to a borrower so that the latter can purchase a home with the money. This type of loan is issued in favour of a property that the borrower plans to buy. It includes the cost of construction as well as the cost of buying the plot or land.

What is a loan against property (LAP)?

A Loan Against Property or LAP is processed in favour of a property that is already in the name of the borrower. It is available for both business as well as personal usage. Unlike home loans or commercial property loans, the borrower already owns the mortgaged security, and there is no end-usage restriction on the funds availed through a loan against property.

Borrower's can apply for a loan against property (LAP) for a large variety of reasons -to fund education, international vacation, emergency medical treatment, the pursuit of higher studies abroad, weddings, for business purposes, etc.

Is a home loan different from an LAP?

To the uninitiated borrower, a home loan and LAP may come across as interchangeable terms. However, they are different from each other.

Interest rates
Loans against property incur higher interest rates than home loans and usually have a maximum tenure of 15 years. This is because the lending institution provides funds against a property that is already owned by the borrower, and there is no restriction on the end-usage of the funds. Home loans are available at much lower interest rates and for a longer duration than LAP, usually upto 20 years.

Monitoring and restrictions Home loans can be availed only for the purpose of purchasing a new / resale house, constructing a house on a piece of land owned by the borrower, or renovating an existing home. In the case of LAPs, borrowers are free to utilise the funds for myriad purposes.

Tax deductions Home loan borrowers can enjoy tax exemption benefits under section 80C for the principal amount and under section 24 for the interest. However, a loan against property will not provide any tax exemption benefits to borrowers.

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Does the repo rate affect the interest rate for loans?*

Interest rates are one of the most important considerations for a would-be-borrower when choosing a lender to take a loan from. It is dependent upon two main factors.

• The borrower's ability to repay, which is calculated based on a number of factors including the repayment capacity, credit score, nature of employment, nature & value of the property, etc.
• The repo rate that has been set by the RBI. A rise or fall in the rate impacts both future as well as existing borrowers.

Financing institutions and banks might pass the rate cut on to the customers. This will affect the monthly installments for the loans.

Why does the repo rate affect the interest rate for loans?*

When applying for a home loan, homebuyers usually prefer a floating rate of interest. If the home loan repo rate falls as soon as the borrower receives the home loan, the latter will have to wait for a revision for one year. This is because most banks base their home loans on the one-year Marginal Cost of Funds based Lending Rate (MCLR).

The average tenure of a home loan is around 20 years. Since this is a long period, even a small change in the interest rates can substantially influence the total cost of the property.

How does the repo rate affect the interest rate for loans?*

A change in the repo rate affects both future and existing borrowers. If the repo rate falls, public sector banks may commensurately reduce their rates so that their consumers can reap the benefits.

With the repo rates reduced, financial institutions or the commercial banks will lower the MCLR which, in turn, will decrease the EMIs on your loans.

Home loan interest rates in India are currently dependent on the following factors – the bank spread in India, the base rate, and the MCLR rate. Hence, the banking benchmark rates determine the effective rate of loan interest. The home loan rates also depend upon the eligibility of the borrower.

The eligibility of the borrower depends upon the following factors

• Nature of occupation / employment
• Income stability
• Qualifications
• Number of dependents
• AgeIncome - includes household income
• Existing EMIs / liabilities
• Existing assets
• Credit Score and history
• Lender's policy at the time of loan application, etc.

Fluctuation in the repo rate also affects the additional charges on a home loan. These include account fees, administrative fees, legal fees, conversion charges, pre-payment charges, late payment charges, and processing fees.

*Please note that repo rate has no effect on the interest rates of loans offered by Grihashakti. Our interest rates depend on our policy, as well as the borrower’s profile and requirement. This article is for your understanding only, and may be applicable to borrowers of lenders whose interest rates depend on repo rate. To avail a home loan or a loan against property, apply online today.

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