Typically, when the Reserve Bank of India cuts the repo rate, it is anticipated to bring some financial relief to borrowers, particularly home loan borrowers. It is due to repo rate, the rate at which the RBI lends money to commercial banks in India, which directly affects lending rates in the economy. Lower repo rates should ideally lead to lower interest rates on loans which should lower EMIs. However, many home loan borrowers have recently been disappointed.
The Reserve Bank of India has decreased the repo rate the third time this year which has bought the total cut to 100 basis points. Home loan interest rates have dropped below 8%, last seen in 2022 giving a potential lifeline for borrowers. Even after these regulatory changes many buyers borrowers are finding that their EMIs remain the same.
This gap between repo rate cuts and unchanged EMIs isn’t coincidental: this happens due to the structure of home loans and the benchmark to which they are associated. The RBI’s rate cuts depend on this one factor which influences interest rate transmission and borrower benefit.
Understanding the Link Between Repo Rate and Lending Rates
Traditionally, when RBI lowered the repo rate, commercial banks were expected to pass the benefit to the customers by reducing loan interest rates. This is based on the concept that lower borrowing for banks results in affordable loans for customers.
In order to make this system more transparent, in 2019, RBI mandated that all new floating rate retail loans such as home loans must be linked to an external benchmark. The RBI’s repo rates the most commonly used benchmark. This intended to increase the speed and transparency of rate transmission to the end user. So, why are EMIs still high for those taking home loans?
Although the repo rate might have decreased, the real lending rate known as the Effective Interest Rate (EIR) depends on more than just the benchmark. Let’s talk about this in detail.
1. Spread or Margin Added by Banks
When banks give loans, they do not provide them directly at the benchmark rate. They add a spread or margin to the repo rate to account for operational costs, credit cards and profit margins. This spread is decided at the time of loan approval and in many cases stays constant during the duration of loan. SO even when your repo rate drops, your overall interest rate might not fall much unless the bank reduces its spread, which is a rare case.
2. Reset Periods and Lag in Transmission
Another hidden issue is your loan’s reset frequency. Even if your loan is linked to the repo rate, interest rates are revised every three to twelve months which depends on your lender’s reset method. For e.g. if RBI cuts the repo rate again in June and your loan’s interest rate is scheduled to be revised in December, you won’t benefit from this for several months.
3. Risk Based Pricing Models
Banks have adopted risk based pricing which means the final interest rate given to a borrower is determined by their credit profile, loan to value ratio and overall risk assessment. So if your credit score is average or if the lender views your loan as riskier, you might not get the best rates even if the repo rate drops.
Internal Benchmark vs External Benchmark
Not every borrower has loans linked to repo. If you your loan was sanctioned before October 2019 and hasn’t switched to the external benchmark system, it might still be associated with older benchmarks like Marginal Cost of Funds based Lending Rate (MCLR) or even Base Rate. These benchmarks react much more slowly to changes in the RBI’s policy rates.
For example, MCLR considers a bank’s funding expenses, operational costs and margin risk. This makes it less sensitive to repo rate changes.
What Can Home Loan Borrowers Do?
If you are still not experiencing a drop in your EMI despite repo rate changes, here are a few practical things you can take:
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Check Your Loan Type
Consider whether your loan is tied to the repo rate or remains based on the MCLR or Base Rate. If it is not repo-linked, try switching.
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Request a Conversion
Most banks allow customers to convert from MCLR-based loans to repo-linked loans for a small charge. This could result in large savings over time.
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Compare Interest Rates Across Lenders
Sometimes, switching lenders can offer better interest rates, especially if other banks are offering more competitive spreads.
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Improve Your Credit Score
Since creditworthiness is a key factor in determining your loan’s spread, maintaining a high credit score can help you secure better terms.
Conclusion
While RBI’s recent decision of slashing repo rate is making headlines all across the country, the reality on the ground for borrowers is more nuanced. Your home loan EMI is not just a function of the central bank’s policy decisions but also of your bank’s internal pricing strategy, your loan agreement terms, and your own credit profile.
Notably, the lack of relief in EMIs despite a repo rate cut isn’t always due to inefficiency in the system—it’s often due to structural reasons embedded in loan agreements and bank policies. For real savings, borrowers need to stay informed, ask the right questions, and be proactive in managing their home loans.
