Factors that influence your loan rate

By abithadeepak | November 10, 2009

Banks have something called the benchmark prime lending rate, which is a reference interest rate that is used as a benchmark to determine the interest rate that is passed on to the customer. This will accordingly reflect in the EMI the borrower has to shell out to repay his loan. The interest rate that is finally passed on to the customer is X% plus or minus this benchmark prime lending rate and will correspondingly increase or decrease his EMI or loan tenure, at the time of applying for his loan.

Money lent by banks and financial institutions for various purposes come with a cost, which is known as the loan rate or the interest rate at which the loan is lent.

In recent times there has been a spate of CRR (cash reserve ratio) and repo rate cuts following which interest rates on home loans have been slashed. This has been a welcome relief for potential, first-time home buyers who have been waiting for this to happen for a long time.

So what do CRR, repo rate, reverse repo rate, SLR, et cetera mean in the context of your home loan interest rate? Well, all these factors have a direct impact on the PLR (prime lending rate), which correspondingly increases or decreases the interest rates of loans.

Let’s take a quick look at what all these terms mean to see how they affect the loan interest rates.

Prime Lending Rate (PLR)

This is the benchmark interest rate on the basis of which financial institutions decide the interest rates on the various loan products. For example, a bank might say a loan interest rate will always be 0.5% above the PLR. This means, if the PLR increases or decreases by a certain amount, the interest rates charged on the floating rate loans offered by the bank also increase or decrease by the same amount.

Cash Reserve Ratio (CRR)

It is the percentage of cash deposits that banks need to keep with the Reserve Bank of India [Get Quote] on an everyday basis. Increasing the CRR also means banks have lesser money to lend. RBI adjusts the CRR to change the amount of liquidity in the financial system, which helps to keep the inflation within reasonable limits.

Also, when CRR is increased, the interest rates also increase as the amount of liquidity in the financial system decreases. RBI has made frequent CRR cuts in the recent past to inject liquidity into the financial system. This is expected to impact the interest rates bunched with other favourable aspects for home loan applicants.

Repo Rate

This is the interest rate at which RBI lends money to the banks whenever they need to borrow funds from RBI. When the repo rate decreases its good news for the banks as they can avail more funds at a lower interest rate and vice versa.

Reverse Repo Rate

This means just the opposite! Here, RBI borrows funds from the banks and when the Reverse Repo Rate increases banks are very happy to lend money to RBI because of the attractive interest rates RBI offers to obtain the loans.

SLR (Statutory Liquidity Ratio) Rate

Every commercial bank needs to maintain a certain amount of funds in some form — which includes cash, gold, government bonds, etc — before they can provide credit to its customers. This measure helps RBI have control over the bank’s credit expansion, keeping it realistic.

The collective impact of all these rates influence the liquidity in the financial system and lead to an increase or decrease in PLR, which in turn affects loan lending rates.

Benchmark Prime Lending Rate (BPLR)

A while ago, those who had been subjected to steep interest hikes in the past eagerly looked forward to see the interest rate cuts from their banks. Some banks were planning to pass on the benefits to the existing customers while some others were cutting down interest rates only for their new customers.

What were the factors that came into play here? How are banks able to give the lower rates only to new customers while keeping older customers at a higher rate? Well, banks have something called the benchmark prime lending rate, which is a reference interest rate that is used as a benchmark to determine the interest rate that is passed on to the customer. This will accordingly reflect in the EMI the borrower has to shell out to repay his loan.

The interest rate that is finally passed on to the customer is X% plus or minus this benchmark prime lending rate and will correspondingly increase or decrease his EMI or loan tenure, at the time of applying for his loan.

This X% is termed a ‘spread’, and is left to the discretion of the bank to set and depends on the other factors involved in loan eligibility like the credit profile of the loan seeker, for instance.

According to RBI regulations, banks are required to make changes in existing loans except fixed interest rate home loans, when they change their existing BPLR.

However, since banks are given the freedom to set the spread from the BPLR at whatever value they choose for new customers, they are able to provide attractive rates to new customers while continuing to charge a much higher interest rate for older customers.

For example, suppose Suresh took a home loan at a floating rate of BPLR minus 2% at a time when the bank’s BPLR was 9%. The floating rate of 7% that he received was attractive and it seemed to be the right decision to choose this loan.

Over time the BPLR of the bank increased to 15% and Suresh’s floating rate became13%. However, Suresh’s bank is now offering a floating rate of BPLR minus 3.5% to new customers, which means that new customers are paying a rate of 11.5%, while Suresh is stuck with an interest rate of 13%.

The irony of this situation is that Suresh signed up for a floating rate knowing that his rate would increase or decrease according to market conditions, not realising that his bank has the power to not share the benefit of a falling rate with him.

From the bank’s perspective this is profitable, as they will end up making more money off Suresh’s loan if they charge him a higher interest rate.

Banks have various clauses in the loan agreement that keep the best interests of the lender in mind as the money outflow from banks, even on an everyday basis is enormous. As shown in the example above, the clause that dictates banks can opt to choose the ‘spread’ from the BPLR is the catch that loan consumers need to be aware of.

However, after what seemed like a long wait banks have started to effect changes in their BPLR in the wake of the current spate of repo and CRR rate cuts.

Every bank has a cycle to bring the benefit of this change to the existing customers. According to bank policies, this change or floating interest can come into effect on a quarterly or yearly basis or with immediate effect.

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14 thoughts on “Factors that influence your loan rate

  1. munish sharma

    i want to know that what should be the interest rate on home loan in the month of 25th december 08 of the bank of punjab and sindh bank new delhi situtated on rs. 6lacs.
    they give on 12.75%. Please suggest me that what should it now.
    Banks has slashes their rates does this bank also.

    Reply
  2. Amit

    Dear Sir,

    I am planning to buy home. SBI is providing loan at 8% for 1st year. I am not knowning what wil be the interest rate after one year in this scheme?

    The option is to get loan at 9.25% for 5 years. After 5 years, i can go for floating or fixed rate.

    I can get loan of Rs. 1,700,000/-. I will planning to take loan for 10 years.

    Pls. advice,

    Regards,

    Amit

    Reply
  3. Amit

    Dear Sir,

    I am planning to buy home. SBI is providing loan at 8% for 1st year. I am not knowning what wil be the interest rate after one year in this scheme?

    The option is to get loan at 9.25% for 5 years. After 5 years, i can go for floating or fixed rate.

    I can get loan of Rs. 1,700,000/-. I will planning to take loan for 10 years.

    Pls. advice,

    Regards,

    Amit

    Reply
  4. Bikram

    This doesn't make much sense (the spread from BPLR part) because when the BPLR will reduce again over time, banks will loose much more amount from customers, where they had put more spreads. In your given example, if BPLR comes down later, banks will loose huge amounts from the new customers they are giving loans now to.

    Reply
  5. Amit jain

    Dear Sir,

    I had taken a Home loan from Deutsch Bank where I was given a discount of 3.5% on BPLR on a Loan of Rs 20L. However, even before my first EMI was deducted, they increased the Interest rate and brought it to their existing rates. No benifit whatsoever was given to me of the difference in BPLR.

    It has been a very bad experience with this bank as their documents are always incomplete and Bank itself unhelpful in resolving queries. I am planning to shift my Loan from this Bank at the first opertunity.

    New customers should be beware of the BPLR discount as private banks do not honour the discount given to a customer at the time of loan disbursements and customers end up paying huge amount of interest during the tenure of their Loans.

    Regards,
    Amit

    Reply
    1. venugopal

      Amit Jain,

      Understanding the practicality of the Clauses of the loan agreements is difficult in the intial phase. experience and finding the nitty gritty of the details is a must.

      Reply
    2. venugopal

      Amit Jain,

      Understanding the practicality of the Clauses of the loan agreements is difficult in the intial phase. experience in this matters and finding the nitty gritty of the details is a must at the planning of the loan.

      Reply
  6. Vasu

    I have taken loan for Rs. 20 lakhs in 2009 @9% with a monthly installment of Rs. 17000/-. This loan is for 20 yrs.

    I intend to pay rs. 5 lakhs lumpsum in 2012.

    How to calculate my new EMi and what will be the banks criteria for reducing this 5 lakhs.

    Reply
    1. venugopal

      Since the loan is 2009 and for 20 years, I have doubt that it can be reduced by paying part payment of 5 lakhs as in this way banks loose money ( past experinece of banks of switching loans) and disturb the projections of payments over a period ie interest. In your case Mr. Vasu. read you bank loan agreement and this clause will 100 % will not be there. This clause was there for the loans taken in 2001 – 2002 as far i know.

      Check with the customer care of your bank and your bank directly.

      Give your comments and status on the premature part payment on home loans for others benefits.
      thanks

      Reply
  7. venugopal

    Most of the People close their Loans prematurely in 5- 6 years and if you calculate the total interest rate for the amount you utlised and paid back the interest with prinicpal, it will be very high.
    At the end of the total payment of the loan you have to calculate the cost of the loan ie the extra money you paid from your salary like processing charges, interest amount and other charges.

    Reply
  8. victor

    Why are Government oversight agencies turning a blind eye to the aspect of Interest rate reduction in favor of the common bank customer.

    It can possibly be solved somewhat by a clause stipulating that the percentage by which the interest (BPLR+/- Spread%) is enhanced by the Lender (Bank), shall also be the % that will be used at the time of reduction.

    Am of course presuming that the BPLR is uniform for all banks and the Government has an oversight of it.

    All this is based on tha assumption that the politician(s) have no other interest except the common man?

    Reply
  9. sandeep

    Hi,
    I am planning to buy a home for which seeking a home loan of Rs 50L, may I request the people to provide me their exp
    1. Selecting bank which u think is better
    2. should i go for floating of fixed rate.

    regards
    Sandeep

    Reply
  10. Pradip

    Hi,
    I am a self employed-non professional planning to buy flat for which seeking a home loan of which amount not confirmed since the property valuation not known by us and the building has been constructed since 49 years before and the flat which iam planning for constructed before 6 years. Estimation given by flat owner is Rs.12 Lacs. kindly suggest as the matter is for entire family residing on same flat on rent from last 6 years.
    regards,
    Pradip

    Reply

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