MCLR or marginal cost of funds-based lending rate was introduced in 2016 to help borrowers avail the benefits that follow RBI’s key policy rate changes. The MCLR system has replaced the base rate system that was in effect since 2010. Subsequently, the RBI directed all financial institutions to allow their customers to switch to MCLR without levying a fee or treating it as a foreclosure.
Alternatively, the base rate was introduced in 2010 to replace the Benchmark Prime Lending Rate or BPLR. Notably, while both MCLR and base rate were introduced with the same objective, they are different from one another. To understand the underlying differences between the two, individuals may consider finding out more than what is MCLR and base rate. Here’s a detailed look.
What is MCLR rate?
The internal benchmarking system can be best described as the lowest interest rate extended by financial institutions, lenders, and housing finance companies to borrowers while availing a loan.
In other words, MCLR rate serves as a benchmark or internal rate for financial institutions. After the MCLR system’s introduction, financial institutions use its norms to sanction loans and decide credit limit renewal.
One must note that the marginal cost of funds-based lending rate is closely linked to lender’s fund cost and repo rate. For instance, when there is a change in the repo rate, the MCLR also changes accordingly. Furthermore, a direct change in MCLR rate also lowers the rate of floating interest levied on home loans. Individuals who plan on availing a housing loan at floating interest rate should become familiar with MCLR and its effect on home loans in detail.
MCLR calculation
The internal benchmark is closely linked with outstanding tenures on loans. It means financial institutions determine the benchmark rate based on the remaining repayment tenure of home loans. One must note that this marginal cost of funds-based lending rate calculation is also based on factors like –
- Tenure premium.
- Operating cost.
- MCF or marginal cost of funds.
- Negative carry on cash reserve ratio or CRR.
The formula is –
MCLR = Marginal borrowing cost x 92% + return on the net worth x 8%
What is base rate?
Before this rate was in effect, the base rate was the minimum interest rate below which financial institutions were not permitted to extend loans. Similar to the MCLR system, financial institutions can offer loans below the base rate. However, the RBI must approve such exceptions.
Base rate calculation
It is determined based on the average cost of funds and the following few factors –
- Unallocatable overhead costs.
- Margin of profit.
- Operating costs.
- Negative carry in the cash reserve ratio or CRR.
- Average return on the net value.
Difference between the two benchmark rates
It can be said that the fundamental difference between MCLR and base rate depends on a few governing factors. For instance –
- The marginal cost of funds-based lending rate is based on marginal cost or incremental cost of funds. Alternatively, the base rate is based on the average cost of funds.
- MCLR is computed after weighing in the tenure premium, whereas; the base rate is calculated after factoring in the profit margin.
- The former is also governed by repo rates, deposit rates, cost of maintaining CRR, etc. Contrarily, the base rate is governed by operating cost and cost of maintaining CRR.
Since the MCLR rate system was introduced to pass down the benefits of repo cuts to borrowers, MCLR-based home loans are more transparent and affordable. Nonetheless, before one decides to switch to this system, individuals must know about MCLR-based home loans in more detail and consider a few things.
Things to consider before switching to MCLR
A borrower should consider these before they switch to the internal benchmark rate –
- Borrowers cannot switch back to base rate once they move to the marginal cost of funds-based lending rate.
- A change in repo rate reflects upon the benchmark rate as well. As a result, it is exposed to the risk of increasing interest rate when the RBI decides to increase the repo rate.
- Individuals who had borrowed a housing loan before the 1st of April 2016 do not have the option to switch to MCLR.
In case, borrowers think that their existing financial institution is levying a high MCLR rate, they can opt for a loan balance transfer. However, before switching to another lender borrowers must factor in associated costs and charges.
Usually, a home loan balance transfer helps borrowers to manage their repayment better by lowering their loan burden. Furthermore, leading financial institutions are transparent about levying additional charges.
Some of them also provide pre-approved offers to customers to make the process of financing quick and hassle-free. These offers are available on several credit options, including home loans and loans against property. Check your pre-approved offer online with the help of name and mobile number.
One must note that the RBI has directed all financial institutions to allow their customers to switch to MCLR without levying a fee or treating it as a foreclosure. Borrowers must weigh in these factors before planning a switch.