Repo Rate Cut by RBI: Reduces Home Loan EMI

With so many people losing their jobs, facing salary cuts due to COVID 19; paying the monthly instalment of their Home loan (EMIs) can be a huge financial burden. To give all those borrowers a small relief the Reserve Bank of India (RBI) declared a repo rate cutback of 40 basis points. Consequently, the repo rate has dropped from 4.4 percent to 4 percent.

Once you hear this announcement, the question that pops up in your mind is possibly what is repo rate? Let’s discuss this.

Repo Rate: What is it?

It is the rate at which Reserve Bank of India; (the central bank of the country) lends money to commercial banks to handle any shortfall of funds. Repo rate (Repurchase Rate) is used by financial authorities to manage inflation. Banks enter into a contract with the RBI to repurchase equivalent guaranteed government securities at a future date at a preset price.

A drop in the repurchase rate is the indication that banks can now make use of funds at cheaper rates from the RBI and lend subsequently.

Now, it is difficult for a layman to understand how this cut can give him a sense of relief. Let’s explain how a repo rate affects your loan burden.

How does the repurchase rate affect home loan?

Banks have linked their home loans with the repo rate since October 2019. Consequently, with RBI’s decision to cut repo rate; banks can lower their interest rates charged on loans. This means, that the credit offered to the customers have lesser interest rates. Consequently, this would drop off the EMI as well. On the other hand, when there’s a trek in the repurchase rate, banks increase their lending rates. In simple words, any change in the repo rate directly has an effect on the Marginal Cost of Fund Based Lending Rate (MCLR).

This cut is undeniably a big relief for home loan borrowers facing a cash crunch because of the nationwide lockdown. People are scared of the associated unfavourable financial crash on the economy.

A simple example to explain the impact of the rate cut on home loan EMI:

Suppose a salaried individual (borrower) has taken a home loan of Rs 30 lakh for a tenure of 20 years. This at present carries an interest rate of 7.65 percent. This means he is at the moment paying Rs 24,444 as EMI. Now, the lender reduces its interest rate by 40 bps to give you the benefit of the slash in the repo rate. Your new ROI is 7.25 percent interest rate. Subsequently, your EMI will come down by to Rs 23,711.

Wrapping up

People are more worried about the financial crisis. Most importantly, they are bothered more about the economic impact of the lockdown than coronavirus. The effort taken by RBI surely gave them a support and sense of relaxation. Giving borrowers (repaying loans) a bit of a breathing room was the objective of the central bank of the country.

Also view Repo-linked Home Loans During COVID-19