The Reserve Bank of India has raised the repo rate by 25 basis points. This is according to the second bi-monthly monetary policy statement for 2018-19 published on 6 June 2018. The repo rate has now increased from 6% to 6.25%. This is the first time the repo rate has increased in more than four years. The last repo rate hike was in January 2014. The reverse repo rate now stands at 6%. The Marginal Standing Facility (MSF) Rate and Bank Rate have also increased to 6.50% from 6.25%.
After the repo rate hike on 6 June 2018, many banks have increased their Marginal Cost of Funds-Based Lending Rate (MCLR) in response to the announcement made by the Reserve Bank of India. This is expected to have a direct impact on the amount of EMI that customers pay for their loans. With the MCLR rates imposed by the banks increasing post the hike, loans are set to become expensive for customers.
What is Repo Rate?
Borrowers take loans from banks and financial organizations, who provide these loans after charging a certain amount of interest. Therefore, the rate at which the borrower takes the loan is known as the Cost of Credit. In the very same manner, banks and financial organizations borrow money from the Reserve Bank of India by selling their surplus government securities. The rate at which they sell these securities to the RBI is known as the Repo Rate, also known as the Repurchase Rate.
A high Repo Rate will result in higher cost of short-term funds. Similarly, if the Repo Rate is low, it automatically brings down the amount of interest which banks will have to pay on the borrowed funds. Therefore, if the Repo Rate is low, it allows banks to charge lower interest rates on the loans which they offer to their customers. Additionally, a lower Repo Rate can also contribute greatly towards generating a positive growth of the economy.
Impact of Current Repo Rate on Loan EMIs
The repo rate that increased on 6 June 2018 will have an impact on both the existing and future borrowers. It generally takes a while after the repo rate is announced depending on the category of borrower you fall in to know the impact of the changes. To begin with, the bank you are associated with might increase the Marginal Cost-based Lending Rates (MCLR). The increase in the Marginal Cost-based Lending Rate will cause the EMI on your loan to go up.
The change in the repo rate is likely to result in an increase in the interest to be paid on a loan irrespective of whether it is a car loan, personal loan or home loan. This is because the repo rate is the rate at which all the banks borrow money from the Reserve Bank of India. The rise in these rates usually tends to have a direct impact on the interest to be paid by the customers.
Impact of Current Repo Rate on Existing Loan Borrowers
Existing loan borrowers will not see changes in their EMI amount even though many banks have changed their MCLR in response to the hike rate by RBI. There is however, a possibility of a change in loan tenure. This will in turn increase the effective cost of the loan as the number of EMIs to be paid will go up.
The long-term interest paid by a borrower to the bank will eventually go up as a result of an increase in the interest rate that will have to be paid to the banks. This will in turn make the overall loan a little more expensive. If you do not want to make any immediate changes to the loan structure, you can always decide to wait and observe the impact that the repo rate hike will have on the loan. Depending on the impact, you can choose to make changes.
One method to reduce the impact of these hikes on interest rates is to make a pre-payment to the bank. Pre-payment can help reduce the total amount of interest you will be paying to the bank. This option is suitable for those who are just starting out their loan tenure. One can also try to increase their savings and investments and pre-pay their loan in order to ensure that the interest paid does not exceed than what you would pay normally. For loans that are nearing the end of their tenure, it is best to not many any changes and try to maintain the loan till the tenure ends.
With RBI announcing to increase the repo rate on 6 June 2018, recent loan borrowers will mostly face an increase in the amount of EMI to be paid depending on their loan tenure. In case the effect of the increase in the repo rate on your loan is high, you also have the option to transfer your loan to another banks after comparing the loan rates they offer and choose the offer most suitable for you.