What is MCLR Home Loan & How does It affect Housing Loans?

When it comes to buying a home, financing is a crucial aspect that requires careful consideration. One of the key factors to weigh is the type of interest rate attached to your home loan. In recent years, Marginal Cost of Funds Based Lending Rate (MCLR) has gained prominence as a benchmark for home loan interest rates. In this blog, we'll delve into the intricacies of MCLR home loans, helping you make informed decisions when navigating the real estate financing landscape.

What is MCLR?

MCLR means Marginal Cost of Funds Based Lending Rate. The Marginal Cost of Funds Based Lending Rate (MCLR) is a benchmark interest rate used by banks in India to determine the minimum interest rate at which they can lend money to borrowers. It was introduced by the Reserve Bank of India (RBI) in April 2016, replacing the Base Rate system.

MCLR is calculated based on various components, including the marginal cost of funds, negative carry on the Cash Reserve Ratio (CRR), operating costs, and a tenor premium. Here's a brief explanation of these components:

• Marginal Cost of Funds (MCF): This is the cost associated with the incremental or marginal funds that banks raise to lend to customers. It includes the cost of borrowings, interest on deposits, and other sources of funds.
• Negative Carry on CRR: Banks in India are required to maintain a certain percentage of their deposits as a Cash Reserve Ratio (CRR) with the central bank. The interest foregone on this amount is considered a negative carry, and it is factored into the MCLR calculation.
• Operating Costs: This includes the operational expenses incurred by the bank in the process of lending, such as administrative costs, staff salaries, and other overheads.
• Tenor Premium: The tenor premium is an additional component that accounts for the time period (tenor) for which the funds are being lent. It reflects the bank's expectation of changes in market interest rates over time.

RBI Requirements Regarding MCLR

The Reserve Bank of India (RBI) introduced the Marginal Cost of Funds Based Lending Rate (MCLR) system in April 2016 with the aim of bringing more transparency and responsiveness in the transmission of monetary policy rates to lending rates of banks. The guidelines for MCLR are issued by the RBI and provide a framework for banks to determine their lending rates based on their marginal cost of funds. Here are the key guidelines issued by the RBI for MCLR:

• Calculation of MCLR Components: Banks are required to calculate MCLR based on components such as the Marginal Cost of Funds, Negative Carry on Cash Reserve Ratio (CRR), Operating Costs, and Tenor Premium.
• Review and Reset Period: Banks are mandated to review and reset their MCLR at least once a month. This ensures that changes in the cost of funds are reflected in a timely manner.
• Different Loan Tenors: Banks must declare MCLR for various loan tenors, such as overnight, one month, three months, six months, and one year. This provides borrowers with options based on their preferences and requirements.
• Transmission of Policy Rates: MCLR is expected to be more responsive to changes in key policy rates, such as the repo rate set by the RBI. This responsiveness is intended to facilitate a quicker transmission of changes in the monetary policy to lending rates.
• Interest Rate Spread: Banks are allowed to charge an additional spread over the MCLR to determine the final lending rate. This spread incorporates factors like credit risk premium, operating costs, and the cost of raising funds.
• Publication of MCLR: Banks are required to make their MCLR methodology and actual lending rates publicly available. This transparency helps borrowers understand how their interest rates are determined.
• Base Rate Transition: Banks are encouraged to transition their existing borrowers from the Base Rate system to the MCLR system. This transition is aimed at ensuring a more transparent and responsive interest rate mechanism.
• Applicability to New Loans: MCLR is applicable to all new loans and existing loans that are due for renewal. This ensures that the benefits of a more dynamic interest rate system are extended to a wider range of borrowers.

MCLR vs. Base Rate: Understanding the Shift

MCLR (Marginal Cost of Funds Based Lending Rate) and Base Rate are two different benchmark interest rate systems used by banks to determine lending rates. Let's compare MCLR and Base Rate to understand their differences:

Aspect	MCLR (Marginal Cost of Funds Based Lending Rate)	Base Rate
Definition	Benchmark interest rate introduced by the RBI in April 2016.	Benchmark interest rate system used before the introduction of MCLR.
Calculation Method	Based on the marginal cost of funds, which includes various factors such as repo rate, cost of funds, operating expenses, and tenor premium.	Calculated based on the average cost of funds, including the cost of deposits and other sources of funds.
Components	Marginal cost of funds, negative carry on CRR, operating costs, tenor premium.	Average cost of funds, cost of providing credit, operating expenses, and a profit margin.
Transmission of Policy Rates	Expected to transmit changes in policy rates more effectively, leading to quicker adjustments in lending rates.	Changes were not as swift, and the transmission of policy rate changes might have been less immediate.
Reset Period	Typically has a predefined reset period for interest rate revisions.	Did not have a mandatory reset period; changes were at the discretion of the banks.
Transparency	Considered more transparent due to a clear methodology and inclusion of various components in the calculation.	Criticised for lack of transparency, as the calculation method varied among banks.
Applicability	Applicable to all new loans and existing loans due for renewal.	Gradually phased out, and banks were encouraged to transition existing borrowers to the MCLR system.

Please note that this table provides a general overview, and specific details may vary among different banks. Always refer to the latest guidelines and information provided by the Reserve Bank of India (RBI) and individual financial institutions.

How to Calculate MCLR?

Calculating the Marginal Cost of Funds Based Lending Rate (MCLR) involves a formula specified by the Reserve Bank of India (RBI). Although the formula may initially seem intricate, breaking down its components can provide a clearer understanding of how MCLR is determined. Here's a step-by-step breakdown:

Formula to Calculate MCLR

MCLR=(MCO×92%)+(RONW×8%)

Components

• MCO (Marginal Cost of Borrowings): Represents the average rate at which the bank borrows funds from various sources such as deposits, repo transactions, and commercial borrowings.
• 92%: Weighting factor applied to MCO to reflect the predominant role of deposits in a bank's funding mix.
• RONW (Return on Net Worth): Represents the desired return on equity (ROE) that the bank aims to achieve.
• 8%: Weighting factor applied to RONW to capture the bank's profit margin and operational expenses.

Example

Assuming a bank's MCO is 8.5% and its desired RONW is 10%, the calculation for MCLR for a specific tenure would be:

MCLR=(8.5%×92%)+(10%×8%)=7.86%+0.8%=8.66%

MCLR for Different Banks

The table provides information about Marginal Cost of Lending Rate (MCLR) for different banks across various tenures, as of January 8, 2024.

Bank	Overnight (%)	One Month (%)	Three Months (%)	Six Months (%)	One Year (%)
Axis Bank	8.00	8.05	8.10	8.20	8.30
Bandhan Bank	6.50	6.93	7.10	7.20	11.27
Bank of Baroda	8.10	8.15	8.20	8.30	8.40
Bank of India	8.00	8.15	8.15	8.45	8.55
Canara Bank	6.70	6.70	6.70	6.70	8.45
Central Bank of India	6.50	6.50	6.50	9.35 (RLLR)	9.35 (RLLR)
Citibank	8.65	8.70	8.90	9.15	9.25
DBS	8.75	8.80	8.95	9.20	9.30
Federal Bank	7.25	7.30	7.40	7.50	8.75
HDFC Bank	8.65	8.70	8.90	9.15	9.25
IDBI Bank	8.25	8.30	8.35	8.40	8.50
IDFC First Bank	8.40	8.45	8.50	8.55	8.65
Indian Overseas Bank	8.10	8.15	8.20	8.30	8.40
Indusland Bank	8.30	8.35	8.40	8.50	8.60
PNB	8.00	8.15	8.15	8.45	8.55
Punjab and Sind Bank	8.00	8.15	8.15	8.45	8.55
RBL (Not Available)	-	-	-	-	-
SBI	8.20	8.25	8.55	8.45	8.55
UCO Bank	7.90	7.95	8.20	8.35	8.60
Union Bank of India	8.20	8.25	8.30	8.50	8.70

• "RLLR" stands for Repo Linked Lending Rate.
• Data for Jammu and Kashmir Bank, Nainital Bank, RBL Bank, and Standard Chartered wasn't readily available. Please check their official sources or contact them directly for the most current lending rates.

Importance of MCLR in Banking

Marginal Cost of Funds Based Lending Rate (MCLR) is significant for several reasons in the banking and lending landscape. Here are some key points highlighting the significance of MCLR rates in banking:

• Transparency and Fairness: MCLR provides a transparent mechanism for determining lending rates. It is based on the actual cost of funds for banks, making the interest rate-setting process more objective and fair.
• Dynamic Nature: MCLR is reviewed periodically, typically on a monthly basis, allowing it to reflect changes in market conditions, interest rates, and the cost of funds for the bank. This ensures that lending rates respond more quickly to changes in the broader economic environment.
• Interest Rate Transmission: MCLR is designed to facilitate quicker transmission of changes in policy rates (like the RBI's repo rate) to lending rates. This helps in aligning the cost of borrowing for banks with prevailing market conditions, making interest rate movements more responsive.
• Flexibility for Borrowers: Borrowers benefit from MCLR's flexibility as it allows them to take advantage of falling interest rates quickly. When MCLR decreases, borrowers with floating-rate loans can experience a reduction in their interest burden.
• Differentiated Lending Rates: MCLR allows banks to set different interest rates for different categories of borrowers based on their risk profile and creditworthiness. This helps in offering more customised loan products and interest rates.
• Asset-Liability Management (ALM): MCLR is linked to the cost of funds for banks, enabling them to manage their assets and liabilities more effectively. This alignment helps banks maintain a balanced approach in managing their interest rate-related risks.
• Compliance with Regulatory Guidelines: MCLR is in line with the regulatory guidelines set by the Reserve Bank of India (RBI). Adhering to these guidelines ensures that lending practises are consistent and comply with regulatory standards.
• Enhanced Competition: MCLR promotes competition among banks by encouraging them to manage their costs efficiently. This can lead to competitive lending rates, benefiting borrowers through better terms and conditions.
• Encourages Efficient Financial Practises: By factoring in various costs and market conditions, MCLR encourages banks to adopt efficient financial practises and manage their funds more judiciously.

MCLR vs Repo Rate

Marginal Cost of Funds Based Lending Rate (MCLR) and the Repo Rate are both key interest rate benchmarks in the financial system, but they serve different purposes and are used by different entities. Let's explore the differences between MCLR and Repo Rate:

Aspect	MCLR (Marginal Cost of Funds Based Lending Rate)	Repo Rate
Definition	Benchmark interest rate for banks' lending rates	Central bank's rate for lending to commercial banks
Calculation	Formula-driven, based on the marginal cost of funds, return on net worth, and other factors	Set by the central bank (RBI) during monetary policy reviews
Usage	Used by banks to determine lending rates for various loans	Used by the central bank to influence inflation and economic activity
Frequency of Review	Reviewed periodically by banks (monthly or quarterly)	Reviewed by the central bank during monetary policy reviews (bi-monthly or quarterly)
Impact on Borrowers	Changes in MCLR directly impact interest rates for borrowers. Reduction in MCLR may lead to lower interest rates for borrowers with floating-rate loans	Indirect impact on borrowers. Changes in Repo Rate influence the cost of funds for banks, which may affect MCLR and lending rates. The impact on borrowers depends on how banks adjust their MCLR
Calculation Components	Marginal cost of borrowings, return on net worth, operating costs, etc.	Set by the central bank based on its assessment of macroeconomic factors
Responsiveness to Market Changes	Responsive, as it is reviewed more frequently by banks	May take time to impact lending rates as it depends on how banks adjust their MCLR in response to changes in the Repo Rate

Banks primarily use the Marginal Cost of Funds Based Lending Rate (MCLR) to determine lending rates for loans. MCLR reflects the actual cost of funds for banks, ensuring transparency and responsiveness to market conditions. While the Repo Rate influences overall monetary conditions set by the central bank, it is not directly used by banks for individual loan pricing. MCLR is the key benchmark for transparent and dynamic loan interest rate determination.

How to Transfer to a MCLR based Home Loan?

Transferring a home loan to a new lender or opting for a different type of home loan, such as switching from a fixed-rate loan to a Marginal Cost of Funds Based Lending Rate (MCLR) linked loan, involves a few steps. Here's a general guide on how to transfer to an MCLR home loan:

• Assess Your Current Loan: Review your existing home loan details, including the interest rate, outstanding balance, and tenure.
• Check MCLR Rates with Potential Lenders: Research and compare MCLR rates offered by various lenders. Consider factors such as processing fees, terms, and customer service.
• Calculate Potential Savings: Use online calculators or consult with the new lender to estimate the potential savings by switching to an MCLR home loan. Consider factors like lower interest rates, reduced EMIs, and overall cost savings.
• Contact Current Lender: Inform your current lender about your intention to transfer the home loan. Inquire about any prepayment charges, foreclosure charges, or other fees associated with the transfer.
• Obtain NOC (No Objection Certificate): Request a No Objection Certificate (NOC) from your current lender. The NOC confirms that there are no outstanding dues and the property documents can be transferred to the new lender.
• Apply with the New Lender: Submit a home loan application to the new lender. Provide necessary documents, including income proof, property documents, KYC details, and the NOC from the current lender.
• Property Valuation and Legal Checks: The new lender may conduct a property valuation and legal checks to ensure the property's value and legal status. This is a standard procedure for loan approval.
• Receive Sanction Letter: Once approved, the new lender will issue a sanction letter specifying the loan amount, tenure, and interest rate.
• Sign the Agreement: Review and sign the loan agreement with the new lender. Ensure you understand the terms and conditions, including the MCLR-linked interest rate.
• Transfer of Documents: Coordinate with both lenders for the seamless transfer of property documents from the existing lender to the new one.
• Loan Closure with Previous Lender: Clear any outstanding dues with the previous lender. Ensure that all necessary documents, including the property documents, are handed over.
• EMI Payments with New Lender: Start making EMI payments to the new lender as per the agreed-upon schedule.

In summary, choosing an MCLR home loan provides transparency and adaptability in interest rate structures, aligning with the Reserve Bank of India's guidelines. For those considering home loans, NoBroker's online platform offers digital convenience, transparent processes, and potentially competitive rates. However, thorough research, comparison with other lenders, and careful review of terms and conditions are essential steps before finalising any home loan, including those offered by NoBroker.

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