While availing a housing loan, borrowers try to negotiate the lowest interest rates on home loans along with the best terms. The pre-requisites to a hassle-free loan approval include fulfilling the lender’s home loan eligibility criteria and maintaining a good CIBIL score, so that one can receive the home loan sanction letter without any unnecessary delays.
Moreover, knowing the essentials of a home loan will help you understand your loan better. One such important facet is the repo rate that borrowers should be aware of as it can increase or decrease their loan interest charges.
What Is Repo Rate?
Repo rate is the rate at which the Reserve Bank of India lends money to commercial banks and financial institutions against government securities. Any change in these rates affects the flow of cash in the market. When RBI slashes the rates, it fuels the economy with increased money supply. But if the rates are hiked, economic growth is restricted due to lesser cash flow.
Significance of Repo Rate
Repo rate stands for REPO or ‘Repurchasing Option’ rate, also known as ‘Repurchasing Agreement’. During a cash crunch, people take loans from lenders and repay them at a certain rate of interest. Similarly, commercial banks and financial institutions too encounter a shortage of funds and, at such times, they borrow money from the country’s apex bank, the RBI.
When lenders obtain a loan against any kind of collateral, it is always at the prevailing repo rate. They sell off eligible securities such as treasury bills, gold or bond papers to the RBI; which they can later repurchase once they repay the loan. Hence, it is called the ‘Repurchasing Option’. But in case, lenders take a loan without offering collateral, it is tendered at the bank rate.
Understanding Repo Rate and Bank Rate
Both repo rate and bank rate are effective tools of the RBI used to control economic activities and money flow in the market. Pledging government securities to the RBI for a loan mainly sets the two apart. Here are some similarities and major differences between them:
Similarities Between Repo Rate and Bank Rate
Both rates influence liquidity and regulate inflation rates. Whenever lenders transfer the benefits of interest rate cuts to customers, they need to lower the base rate, which is the minimum rate at which banks can lend to customers. When the Base Lending Rate reduces, loan rates drop subsequently lowering the EMIs.
Differences Between Repo Rate and Bank Rate
Along with certain similarities, repo rate and bank rate have a few striking differences as well, which are:
| Repo Rate | Bank Rate |
| Banks and financial institutions pledge securities that serve as collateral for loans | Lenders borrow money without any security |
| Repo rate is lower than the bank rate as RBI lends against securities | RBI lends cash without collateral; therefore, bank rate is always higher than the repo rate |
| Repo rate loans are offered for a short duration | Loans at bank rate are given for a longer term |
| Lenders may take time to alter the loan interest rates since repo rate changes have a smaller span. It usually affects big-ticket loans like home loans | Bank rate influences the loan rates directly |
How Is Repo Rate Calculated?
The RBI Governor presides over the bi-monthly meetings of the Monetary Policy Committee (MPC) that comprise six members. They develop, allocate and modify policy rates according to the existing liquidity crunch or surplus in the country.
How Repo Rate Functions
Lenders take loans from RBI against securities and repurchase them the next day. This acts as an overnight fund when undergoing a cash crunch. Generally, repo loan is given for one day at Overnight Repo Rate. But if lenders require more number of days, then the loan is tendered at Term Repo Rate or Variable Rate Term Repo. RBI announces an auction for term repo since it can vary from 7, 14 or 28 days. When inflation is higher, RBI increases the rate to check it. At other times, RBI reduces the repo rate to infuse liquidity with a lower cost of credit for borrowers.
Also Read: All About REPO Rate
Consequences of Repo Rate Changes
Any fluctuation in the repo rate, even by a few basis points, can greatly affect credit availability, inflation and economic development. The slightest changes in the financial system can push the economy towards growth or stagnation. Thus, a repo rate hike or fall will influence the market in the following ways:
Impact on Inflation and Economy
A rise in repo rate means that lenders avoid borrowing to refrain from paying higher interest. They take care not to overspend the cash reserve by minimising their loan grants. This obstructs the money flow and financial activities deterring inflation.
But in case of a drop in the repo rate, lenders are encouraged to borrow, lend and invest. With more money available for investments, an improved cash flow facilitates business opportunities and boosts the economy.
Effect on Loan Rates
If the repo rate is hiked, lenders have to repay their loans to the RBI with a higher interest amount. It spills over to their own loan offerings for which they may charge a higher rate of interest. Such a situation discourages both lenders and customers from borrowing. This drains out excess liquidity from the market thereby controlling the inflation rate.
On the other hand, when the repo rate declines, RBI offers lower interest to lenders, who in turn, can reduce their loan rates and seek more customers. This scenario expedites the demand for home loans and other forms of credit. While customers enjoy loans at a lower interest, lenders stand to profit as well. The economy booms due to enhanced money flow as the cost of funds goes down.
Summing Up
Apart from loans, lenders also adjust the interest on fixed deposits or savings accounts as per the repo rate. It is a crucial benchmark for setting up all banking-related rates. So before you avail of a housing loan, keep in mind the factors that can effectively make your loan costlier or cheaper. You can also use an online home loan calculator to compute the exact EMI outgo before applying for a home loan.
