Existing home loan borrowers must move to external benchmark loans

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Existing home loan borrowers and micro, small, and medium-scale enterprises have a new option — loans linked to an external benchmark.


The Reserve Bank of India (RBI) mandated in October that all new floating rate loans will be linked to an external benchmark — this is the new normal for loan seekers.


With the State Bank of India announcing a 25-basis point cut in the external benchmark from January 1, borrowers linked to this would reap the benefits soon.


Old borrowers can explore this option because calculations are much more transparent than the benchmarks that they are currently linked to, such as the marginal cost of funds-based lending rate (MCLR) or the more archaic, base rate or benchmark prime lending rate.


This nudge to move is important because the Janak Raj Committee, set up by the RBI to review MCLR in 2017, had found that 30 per cent of the customers of four leading banks had not shifted to the MCLR despite its implementation 18 months back, and worse, many were still on the base rate or benchmark prime lending rate. Clearly, once borrowers avail of a long-term home loan, they forget to keep abreast with the latest developments or are simply lazy.


Says Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors: “We recommend moving to the external benchmark rate. One of the consistent challenges around rate cuts in India has been that the transmission to existing borrowers has always been much weaker. The rationale behind moving to an external benchmark from an RBI perspective came from there. We think that for investors still sitting on either a base rate, MCLR lending mechanism, should shift to an external benchmark.”


Adds Swapnil Kendhe, a Securities and Exchange Board of India-registered investment advisor and founder of VivekTaru, says: “Whenever you stand a chance to get a better rate, you should take that opportunity — either by switching to another lender or negotiating with the same.”


Currently, most banks have chosen the repo (repurchase) rate as the external benchmark. Given that the RBI monetary policies regularly give borrowers an idea of the repo rate, there would be a lot of transparency. There are several other advantages, too. For one, while the bank is free to decide the spread of a loan, it can only change the credit-risk premium when the borrower’s credit assessment undergoes substantial change. Also, other components of the cost, including operating cost, can only change once in three years. There is unlikely to be high volatility in the equated monthly instalments, because the rates will change once a quarter.


As far as the process goes, existing borrowers who can prepay will be eligible to shift to the benchmark-linked rate without any additional charges, except reasonable administrative and legal costs, says the RBI.


Adds Dhawan: “The cost may or may not be there depending on whether customers are moving to the new rate mechanism with the existing player. There is additional cost also involved. For instance, documentation cost, which resurfaces during this process. While it is easy to try and do this with their existing lender, the ideal thing to do is go into the marketplace and look at alternatives. And then make a choice, rather than just trying to restrict yourself to the existing lender.”


Of course, shifting may not make much sense if you are in the last couple of years of repayment. But if you have taken a loan two-three years ago, it might be worth going for it.

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