Impact Of REPO rate on Home Loan

Repo rates are one of the most critical tools that any central bank has in its kitty through which it exercises its authority to manage and maintain a sound and robust financial system of the economy. It is broadly defined as the interest rate at which the central bank lends money to commercial banks. The central bank in India i.e. the Reserve Bank of India (RBI) uses repo rate to manage and maintain healthy and sustainable liquidity in the financial system. When there is a shortage of funds, commercial banks borrow money from the RBI which is paid back according to the repo rate. The central bank increases the repo rate when they need to control prices and restrict borrowings. On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.

An increase in repo rate means commercial banks have to pay more interest for the money they borrow from RBI. Therefore, a change in repo rate eventually affects public borrowings such as home loans. From interest charged by commercial banks on loans to the returns from deposits are indirectly dependent on the repo rate. 

When there is a hike in the repo rate, home loans will be priced higher and the majority of existing home loans having floating interest rates will see a rise in their EMIs (Equated Monthly Instalments).   

Additionally, the interest rates for existing borrowers linked to financial institution’s internal benchmarks rate, which indirectly depended on the current Repo rate i.e cost of borrowing money from the market. The applicable interest rate, hence will be calculated after factoring in the borrowing cost, internal benchmark rate & credit spread.

For example, on a running home loan of Rs. 50 lakh with a tenure of 20 years at 7% monthly interest, if the rate increases to 7.4% then the EMI will increase to Rs. 39,974 from Rs. 38,765. Alternatively, the rise in interest rate can be absorbed by increasing the loan tenure, hence keeping the EMI same. In any case, a financial institution informs its customers about the reset in EMI or Tenure of loan. 

What is reverse repo rate?

Reverse repo rate is the interest which banks charge from the RBI, to lend credit to the banking regulator. Reverse repo rate is another tool used by the RBI, to maintain desired inflation levels, by way of absorbing liquidity from the system. By increasing interest, the RBI encourages banks to lend money to the RBI, which results in depletion of excess liquidity from the system. Banks, thus, are not left with a lot of credit to lend.

What is monetary policy review?

The RBI’s six-member Monetary Policy Committee, headed by the RBI governor, meets every two months, to decide its monetary policy and tweaks key interest rates, according to the prevailing economic condition. The monetary policy review also sums up the prevailing economic conditions of the country and elaborates on present and future actions that RBI plans to undertake, in order to support the economy.