A Handy Guide on Switching Home Loan Base Rate to MCLR
Individuals going with a floating interest rate may face an important choice at some point of their interest cycle. This involves switching from the bank base rate to the marginal cost of funds based lending rate (MCLR).
But first we must understand the concept of a base rate. This is the minimum rate decided by all banks below which they cannot charge their customers. However depending on the profitability of banks and how they manage their losses, this base rate differs for different banking institutions.
Before the base rate was devised, banks used to give customers a prime lending rate (PLR). In this case the banks could give a person a rate lower than the PLR in case of a low risk loans. Following this a base rate was introduced by the RBI to ensure more transparency, as it is mandatory for all banks to disclose their base rate to their customers.
Yet there exists a practical concern with the base rate. Whenever the RBI passes a benefit to the banks, the banks are not quick in responding to revise the base rates and pass on these benefits to their customers. And in cases where the benefit was passed, it was not passed completely or involved a delay that rendered the benefit of no use to the customer.
Hence to further improve the process, MCLR was introduced from April 2016. It is expected that the MCLR shall be resetting the interest rates on a more real time basis.
Additionally, the MCLR also comes with an interest reset option, which makes it mandatory to reset the interest rate at least once a year. Also once the interest rate is on MCLR it becomes fixed till the next reset date.
This reset date varies for each bank, with some offering a rest period of 6 months. This is an option that can be beneficial to the customer when interest rates have gone down.
Currently banks are offering to convert loans from base rate to MCLR on the basis of mutually acceptable terms. This shifting of rates does not amount to a change of loan, but banks do have a charge for this transfer. With service tax and actual cost to a borrower, this charge comes to about 0.58%.
It is recommended to convert from base rate to MCLR as it aims to reflect the change in rates in real time and is also better regulated. However you’ll need to look into the different ways in which this change affects you financially in terms of your EMI amount, tenure of loan and the overall savings reflected.