MCLR rate and its effects on loans demystified

MCLR stands for Marginal Cost of Funds based Lending Rate. A bank determines its minimum interest rate by considering factors such as its cost of funds, operating costs, and profit margin. Banks use MCLR to calculate the interest rate on various loans, including home loans. The interest rate on a home loan is usually set at a fixed percentage above the MCLR, known as the "spread."

When the MCLR changes, the interest rate on loans linked to it also changes. This means that the EMI amount will increase or decrease depending on the direction of the MCLR movement. In general, a lower MCLR will lead to lower interest rates and, thus, lower EMIs for borrowers. A higher MCLR will lead to higher interest rates and higher EMIs for borrowers.

It is important to note that MCLR is not the only factor that determines the interest rate on a home loan. Other factors, such as the borrower's credit score and the loan tenure, also play a role in determining the final interest rate.

MCLR was designed to address issues associated with the base rate regime and to enable borrowers who take loans. This also includes home loans and helps the borrower to take advantage of the rate cut imposed by the RBI.

Today, as a borrower, you have the option to shift loans taken before April 1, 2016, to the MCLR mode and avail the benefits of the apex bank’s rate cuts. Loans taken on or after this date are linked to the MCLR. Read on to know what exactly MCLR is and how it affects the borrowing exercise.

MCLR refers to the minimum interest rate below which financial institutions cannot lend, except in certain cases. Earlier, when banks and financial institutions did lend on base rates, its prime customers used to get undue advantages.

For example, if the base rate of lending was 7%, certain financial institutions would lend to their prime customers at 7% or below. Alternatively, for ordinary customers, this rate of interest could have been 10-12%.

Since base rate was a financial institution’s internal policy, this caused a huge monetary loss. Also, even after rate cuts, a lot of time was taken by financial institutions to lower their lending rates and pass the benefits to customers.

Additional Read: All you need to know about MCLR based home loans

However, the current Marginal Cost of Funds based Lending Rate (MCLR) aims to:

• Bring the much-needed transparency in financial institutions while determining their interest rates
• Pass the benefits of reduced interest rates to customers
• Ensure availability of loans to customers that is fair to both customers as well as the lender

Also, under MCLR, it is mandatory for banks to declare their overnight, 1-month, 3-month, 6-month, 1-year, and 2-year interest rates every month. Now you, as a borrower, can know the MCLR rates of banks from their websites.

With pre-approved offers on home loan, business loan, and personal loan among others, availing finance is an easy and hassle-free affair. Know about your pre-approved offer within seconds by providing a few basic details.

With MCLR rates pushing up EMIs, you can take certain steps to reduce its impact. Two effective strategies are:

If you have availed of a loan after April 1, 2016, then it is automatically linked with the MCLR mode. However, if your loan was taken before this date and linked to the base rate regime, you can always switch to the MCLR mode. If your loan is nearing completion of its tenure, it is better to stick with the base rate.