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Why has your bank not reduced your home loan interest?

Whenever the Reserve Bank of India announces a hike in its monetary policy rates, home loan lenders like banks and financial institutions quickly increase their interest rates. However, the same reflection of the fluctuations in home loan interest rate is never seen when there is a decrease in the home loan interest rate by the Reserve Bank of India. While this seems unfair and unethical from the borrower’s perspective, the goal of the lenders is just to earn more and more profit. The question is— Why do the banks and other financial institutions not reduce the home loan interest rate, and why do the policymakers turn a blind eye to such unethical practices?

If there is an increase in the index rate, the interest rate also goes up generally. In most cases, the borrower must pay higher amounts of Equated Monthly Instalments. On the other hand, if there is a decrease in the interest rate, the EMI amount should also decrease. Despite a rate hike, the EMI is often kept constant by the lenders, but the repayment tenure is increased. However, this needs to be checked by the borrower with their individual lender. The borrower should also make use of a home loan EMI calculator to get the most favourable interest rates on the home loan. 

Firstly, you need to clearly understand two types of home loan lenders. One— banks regulated by the Reserve Bank of India and second— financial companies like LIC Housing Finance and the HDFC, which are governed by the National Housing Bank. Two different types of loan interest rates are offered by banks and housing finance companies on home loans— fixed and floating. 

 Fixed interest rate loans

For fixed-interest rate loans, the interest rate is fixed either for a certain period of the loan repayment tenure or the entire tenure. If it is fixed for a certain period of the loan repayment tenure, the reset clause needs to be read and understood by the borrower.

Floating interest rate loans

The floating interest rate loans change with the fluctuations in the market interest rates. When there is a hike in the market rate, there is an increase in the Equated Monthly Instalments (EMIs) and vice versa. However, it is often seen that despite the decrease in market rates, the EMI amount remains static.

There are two components of a floating interest rate— the index and the spread. The index quantifies the interest rates depending on benchmark prime lending rates (BPLR) or government securities prices. The spread is an extra amount added to the profit markup and the cover credit risk by the lender. Although the amount of spread may vary from lender to lender, it is generally static over the loan’s repayment tenure. 

Why don’t the banks reduce their home loan interest rates?

The Reserve Bank of India reduced the repo rate to 7.75% by 25 basis points for the first time since May 2013. The benchmark interest rate has been kept by the Central Bank at 8% since January 2014. However, in spite of so many expectations from borrowers, hardly any change was seen in the interest rate charged by lenders. This happens because the Reserve Bank of India has offered freedom to banks to set their home loan interest rate. In its master circular that was issued publicly on July 1, 2014, RBI stated that the banks could determine the interest rate with the approval of their boards, keeping in view the degree of risk, size of the accommodation, and other relevant factors.

Recently, the Reserve Bank of India has allowed banks to reevaluate their base rate computation formula every three years. Previously, it would be reevaluated every five years. However, the higher average cost of funds is still cited by bankers for not reducing the interest rates on home loans in spite of the reduction by the RBI. Whenever the monetary policy shows a rate cat, the interest rate on deposits is first reduced by lenders, and the base rate is reduced only when the average funding cost comes down.

Another reason for lenders not changing their home loan interest rate is because such an action impacts their portfolio and, therefore, their balance sheet significantly. Most banks and financial institutions employ the average cost of funds for the previous quarter to set their benchmark interest rates.

Conclusion

In conclusion, home loan interest rates are important to consider when you’re shopping for a mortgage. A higher interest rate will increase your monthly payment, but it may also mean that you’ll pay more in interest over the life of the loan. On the other hand, a lower interest rate could save you money each month, but you might end up paying more in total interest. Ultimately, the best decision is to compare offers from multiple lenders and choose the one that’s right for your unique financial situation.

We hope this blog helps you understand why banks don’t reduce their home loan interest rate even when RBI does so. You must use a home loan EMI calculator to find out the most favourable EMI options for your home loan. 

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