A new method of bank lending called marginal cost of funds based lending rate (MCLR) was put in place for all loans, including home loans, after April 1, 2016. Earlier, loans were linked to the bank's base rate. While new borrowers after April 1, 2016, can only take MCLR-linked loans, the borrowers on the base rate have the option to switch to MCLR.
Under the MCLR mode, the banks have to review and declare overnight, one month, three months, six months, one-year, two-year, three-year MCLR rates each month. The actual lending rates are determined by adding the components of spread to the MCLR. So a bank with a 1-year MCLR of 8% may keep a spread of 0.5%, thus the actual lending rate becomes 8.5%.
Banks may specify interest reset dates on their floating rate loans and currently have 12 months reset clause. The periodicity of reset is one year or lower. The MCLR prevailing on the day the loan is sanctioned will be applicable till the next reset date, irrespective of the changes in the benchmark during the interim period.
For most MCLR-linked home loan contracts, the banks reset the interest rate after 12 months. So if someone has taken a home loan from a bank, say in May 2016, the next reset date will be in May 2017. Any revisions by the Reserve Bank of India (RBI) or the banks will not impact equated monthly instalments (EMIs) or the loan.
In a falling interest rate scenario, quarterly or half-yearly reset option is better, provided the bank agrees. But when the interest rate cycle turns, the borrower will be at a disadvantage. After moving to the MCLR system, there is always the risk of any upward movement of interest rates before you reach the reset period. If the RBI raises repo rates, MCLR, too, will move up.
Source: economic times