What is Repo Rate?

The rate at which the RBI lends money to banks is known as the Repo Rate. 

It is one of the most important instruments used by the RBI to deal with a general increase in prices and fall in the purchasing value of asset and deficit of funds to maintain the liquidity in the market.

Let’s understand this with an example:

Suppose a bank avails a loan of ₹100 from the RBI, at 6% Repo Rate, then the bank needs to pay ₹6 as an interest to the RBI.  

Role of Repo Rate

Repo rate plays a very important role in controlling inflation in the market, this is done by increasing the repo rate by RBI which eventually reduces the borrowing by the banks. On the same hand when RBI needs to push the economy, it decreases the repo rate which results in increased borrowings by the bank which gradually increases the borrowing by the people. 

The yet another thing which is important for you to know is – The Reverse Repo Rate. This is the rate at which RBI Offers deposit to the banks. You must be wondering that now only we discussed that banks take a loan from RBI, and now we are talking about banks deposit. Well, there is nothing much to get confused. It is quite similar to how you take a loan from a bank when you are out of money and deposit money in the bank as well when you have more than what you can spend.  

In brief, you can say that repo rate and reverse repo rates influence the bank lending and investment rates.

Effect of Repo Rate Cut on Your Home Loan EMIs

The decrease in repo rate results to decreases the fund-borrowing cost for banks, and this leads to a decrease in the MCLR. 

Let us understand this in detail.

When Repo Rate decreases banks get funds at a lower rate, and when they get funds at a lower rate they decrease the Marginal Cost of Funds Lending Rate. This further results to decrease in the interest rate of MCLR loans and as home loans are MCLR based loans hence, the interest rate for home loans is also decreased. As the interest rate is directly proportional to the EMI which you pay, the decrease in the interest rate results in lower EMIs.

However, this is not always true, it is possible only when the banks are ready to pass on the benefit which they are availing to their customers. 

Banks are not so quick in lowering the home loan interest rate even when there is a cut on the repo rate, as by decreasing the interest rate the profit which they are making decreases eventually. So, to earn more profit banks and other lenders are not so quick to reduce it. One of the other reasons is if the banks implement it they need to do lots of change in their database, and lots of calculation is needed to be revised for the existing home loan borrowers, however, it is not that difficult for the new once to who banks are about to offer a home loan.

An example.

Suppose a borrower taken a home loan from SBI. The loan is of ₹20 lakhs and the interest rate charged against it is 8.80% p.a.

Suppose there is a cut in the repo rate by RBI, and SBI agrees to pass on the benefit of the repo rate reduction to its customers and lowered the interest rate for the home loan to 8.50% as per the reduction in the repo rate. 

This decrease in the interest rate will reduce the payable EMIs, with a slight difference. But as the home loan is a long tenure loan hence even by a small reduction in the EMI borrower can save a lot long tenure. 

Hope that the current repo rate cut would translate into lower home loan EMIs and would help soften home loan rates. It will also affect the market by attracting buyers to invest in real estate.