Reducing interest rate cycle: Is it time to rethink your home loan repayment strategy?

The Reserve Bank of India’s latest 25-basis-point (bps) repo rate cut has brought cheer to home loan borrowers. This is the central bank’s fourth rate cut this year, totaling a 125 bps reduction. The rate cuts will particularly benefit home loan borrowers who took loans in 2020-2022 at cheap rates of 6-6.5%, but saw the rates zoom to 9-9.5% within a year following the central bank’s cumulative repo rate hike of 225 bps between May 2022 and March 2023.

Repo-linked lending dominates the retail loan market, so even a small cut ripples quickly through borrowing costs, lowering interest outgo for the borrower over the loan tenure.

Punjab National Bank (PNB) has lowered its Repo Linked Lending Rate (RLLR) by 25 basis points, following the RBI’s repo rate cut. Other major banks are yet to announce their RLLR cuts.

How long rate cut transmission take

When the RBI trims the repo rate, transmission to home loan rates depends primarily on the borrower’s loan structure. Existing borrowers whose loans are pegged to external benchmark rates, such as the repo rate, will see the revised rate applied on their next scheduled reset date, said Jagadeesh Mohan, co-founder, EMI Saver.

With most banks operating on monthly resets, the 25-bps cut announced last week should show up in EMIs or loan statements by the end of the month. “No paperwork or request is required. Customers can verify the change through their loan portal or bank notifications,” Mohan added.

In most cases, interest rates of repo-linked loans move in sync with the policy rate, which means a 25 bps cut should translate into a 25 bps cut in your loan interest. The final rate, however, is the benchmark plus a fixed spread determined by the bank. If the spread remains unchanged, borrowers should see a near-identical reduction.

Prospective borrowers should wait at least one month to get the benefit of the revised rates as per the recent rate cuts. “For new borrowers, banks may decide how much of the rate cut to pass on based on their pricing strategy and market competition. Revised offers generally become available from the following month onwards,” said Mohan.

How the loan repayment strategy changes

With policy rates trending downward, borrowers should reassess their loan terms and market options. When banks revise the interest rates in line with the change in key policy rates, the default option that they exercise is to adjust the loan tenure. However, if you prefer lower EMIs to free up your disposable income, you will need to ask the bank to reduce your EMIs.

Second, if your bank doesn’t fully transmit the rate cuts, you must negotiate for a lower rate if you have a good credit score. However, most private banks charge a fee to reduce the interest rate. It would help to check the prevailing market rates to compare where your loan rate stands. If your effective rate is materially higher than prevailing market levels, it may even be time to change your lender.

Mohan said switching lenders (balance transfer) is usually beneficial if the rate difference is 50 bps or more, since time, effort, and some charges are involved.

The rate cycle is turning in borrowers’ favour. Use this window to optimize your loan terms and lock in long-term savings.