MCLR in Home Loan – What Does it Mean and how is it Calculated?

MCLR in Home Loan
MCLR in Home Loan

The base rate lending system prevailed in India’s retail loan market until 2016, when the Reserve Bank of India introduced the MCLR system. It became the new benchmark for lending rates, ensuring a more transparent system when it came to changes in home loan interest rates. Nevertheless, before learning more about MCLR rates, one should understand what it means and how it is calculated.

What is the MCLR rate?

MCLR stands for Marginal Cost of Funds based Lending Rate, which represents the lowest interest rate which a financial institution can offer to borrowers. MCLR rates rely on four components, each of which influences the overall rate of home loans and other retail loans. These four components are – 

  • Tenure premium – MCLR is based on the tenure of the home loan that a borrower opts for. Depending on the tenure length, this premium varies from one borrower to another. Individuals opting for long tenures need to pay higher premiums and vice versa.
  • Operating cost – While learning about MCLR and its effect on loan, one is likely to come across the provision for operating cost. HFCs must consider the cost of operations, which can be significant in some cases. Financial institutions must raise such expenses from its customers by considering it in the MCLR rates.
  • Marginal cost of funds – This refers to the cost of raising funds, which the lender offers as loans to its customers. 
  • Negative carry on Cash Reserve Ratio (CRR) –Negative carry on cash reserve arises when the return from the loan is lesser than the actual cost of funds. 

Now that you know what is MCLR, you must assess how HFCs calculate this before lending money to borrowers.

How to calculate MCLR rates?

The RBI has presented the following formula for the calculation of MCLR rates for the lending institutions – 

Marginal cost of funds = (92% x marginal borrowing cost) + (return on net worth x 8%)

Why was the MCLR system introduced?

One of the most essential things you need to know about MCLR-based home loans is the reason for its introduction. Here are the two most vital reasons why RBI implemented this change – 

  1. Increasing transparency when it comes to the determination of interest rates on housing loans.
  2. Availability of such credits at interest rates which are beneficial to borrowers and lenders, at the same time. 

For home loans linked to MCLR, interest rates are revised every 6 months to a year. The final rate, which HFCs quote to a borrower, is derived from considering current MCLR, along with the spread.

What is spread in terms of home loan rates?

The spread is a factor that depends solely on the borrower and his/her profile. While MCLR rates are internal benchmarks which borrowers cannot alter, one can change how much spread is added to the base MCLR.

Spread relies on the following factors – 

  1. The credit score of a borrower – Individuals with higher credit scores can lower this spread factor, thereby reducing the overall home loan interest rates. Others will need to pay a greater amount of interest since their credit profile falls short of the qualification.
  2. Loan tenure – A significant tenure can reduce EMIs but increases the overall interest outgo. Long tenures also increase the spread, causing one to avail of such home loans at higher interest rates.

Reputed financial institutions offer a transparent look at MCLR rates and interest rates on home loans in general.

These HFCs also provide pre-approved offers to enhance the convenience and speed of loan applications. Such offers are available on a range of secured credits, such as home loans and loans against property. You can check your pre-approved offers by submitting your full name and phone number. 

Before availing of a housing loan, also consider whether your need to opt for MCLR or Repo-linked credits. Both of these have their benefits and drawbacks, which is why you should deliberate carefully.