The Reserve Bank of India (RBI) paused the repo rate at 6.50% this month. This is a good time to calculate the difference between the repo rate and your Home Loan rate. That number is essentially the markup on your Home Loan.
Interest rates have been rising in lockstep with the repo rate. But the markup on those loans have fallen to a three-year low. For example, if a bank offers a Home Loan at 8.40% interest when the repo rate is 6.50%, it implies a markup of 190 basis points over the repo—a steep decline from March 2020 when the lowest markup was 275 basis points. One basis point is one hundredth of a percentage point. With the repo rate going up from 4.00% to 6.50% now, it has turned 20-year Home Loans into 35-year ones. Loans issued before 2020 have a significantly higher markup than those issued recently. Therefore, the fall in markups presents an opportunity for homeowners to get out of debt faster. How? By refinancing to a lower rate—and therefore a lower markup. Let’s understand this phenomenon better.
A typical Home Loan rate consists of a benchmark rate and a markup. For example, a large government bank says its lowest markup is 265 basis points, over the repo. So 6.50 (current repo rate) plus 2.65 (markup) equals 9.15, which is the lowest Home Loan rate from this bank. The markup is shaped by factors such as the borrower’s Credit Score, source of income, the loan size, and often their gender. The more creditworthy you are, the lower your markup.
Since October 2019, banks have benchmarked retail loan rates to the repo. With this, the decline in markups started. The repo was 5.15% at the start of March 2020. The lowest Home Loan rates then ranged between 7.90% and 8.60%, implying markups of 275-350 basis points. By March 2022, the lowest markups over the repo had reduced to 240 basis points. This came down to 190-200 basis points in March this year.
Repo benchmarking has reduced the discretionary powers banks had in resetting the floating rates on outstanding loans. Now, any change in the repo rate is met with an equal change in your loan rate once every quarter. But only the benchmark rate must change within your rate. Your markup—and this is critical—must remain fixed for the duration of your loan. The RBI allows banks to raise the markup only if the borrower’s credit score declines during the loan. The new benchmarking regime has warmed up home finance. As with the repo rate, interest rates rose rapidly. So, to price their loans competitively, banks slashed their markups. Hence, as interest rates on outstanding loans soared over 9.00%, new loans are being issued at under 8.50%. This massive differential presents an opportunity for homeowners.
Thanks to repo benchmarking, we saw a sharp and immediate decline in Home Loan rates in 2020. By 2021, we had most lenders at sub-seven rates, which was unthinkable earlier. Home financing got cheap. Now, consider a loan with a markup of 190 basis points. If the repo rate fell to 4.00% someday, this loan would be priced at just 5.90%. If you’re on an older loan with a much higher markup, a refinance to a lower rate is sensible. You’re not just locking into a lower rate and spread, you’ll also accelerate out of debt once the repo reverses. Assume you have taken a Home Loan at 9.50%, which you refinanced to 8.50% for 20 years. If the repo rate is cut to 5.50% within a year, your loan rate will fall to 7.50%. With a constant EMI (equated monthly instalment), your loan tenor would reduce to around 17 years without any prepayment.
Do note that rates are cyclical. But if you’re a prime borrower with a high Credit Score, stable income, and standard loan payments, and still paying a high markup, consider a refinance. A low markup will be critical to being debt-free quickly.
This article first appeared on Livemint.
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