RBI repo rate cut: Cheer for borrowers but interest rate on FDs likely to fall further

This cut is sweeter for new borrowers as banks are supposed to link all new floating rate loans to four external benchmarks specified by RBI from October 1.

Personal finance takeaways from RBI's monetary policy
There is good news for those looking at taking a new loan as the Reserve Bank of India (RBI) announced yet another repo rate cut. For the fifth consecutive time this calendar year, the central bank cut the repo rate by 25 bps and the reverse repo by 25 bps (100 bps = 1 per cent).

This cut is sweeter for new borrowers as banks are supposed to link all new floating rate loans to any of the four external benchmarks specified by RBI from October 1. External benchmark linked loans are supposed to make transmission of RBI's rate cuts down to the borrower faster.

After this announcement, the repo rate stands at 5.15 per cent and reverse repo rate at 4.90 per cent. In total, the RBI has cut rate by 135 bps starting from February 2019 till today in five successive steps.


Here is a look at how today's rate cut will impact new and existing borrowers, and fixed deposit (FD) investors.

Interest income from FDs likely to fall
Those investing in FDs, especially senior citizens who are mainly dependent on the interest income from these deposits, are likely to see a reduction in their income.

Due to the successive cuts in repo rate from the start of the year, banks have been reducing interest rates on FDs for few months now. SBI has already reduced its FD rates thrice since August. Currently, the interest rate on SBI's one-year FD is 6.5 per cent.

So, if you are looking to invest in fixed income, maybe you could look at other investment options. For instance, the government has kept interest rates on small savings schemes (like PPF, NSC, SSY, post office term deposits and Senior Citizens' Saving Schemes) unchanged for the October-December quarter of FY 2019-20. Their returns are slightly higher compared to FDs. For instance, Post office term deposits come with interest rates between 6.9-7.7 percent (paid out on a quarterly basis), and PPF will earn an annual interest of 7.9 percent.

For SBI customers, it is not just bad news on the FD front, the bank may even reduce the interest rate on savings account with balances above Rs 1 lakh. This is because the bank has linked the interest rate of savings accounts with balances above Rs 1 lakh to the repo rate.

Account holders will have to wait and watch to see if the bank will cut the interest rate on these accounts. Remember post the last monetary policy held in August, SBI had decided not to reduce the interest rate for such account holders keeping it at 3 per cent. Had the interest rate been reduced, these account holders would have been earning 2.65 per cent.

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With effect from May 1, SBI has also linked its cash credit and overdraft accounts with limits over Rs 1 lakh to repo rate. The interest rate charged on these accounts is 2.25 per cent above the repo rate. With the reduction in repo rate, the interest rate on these accounts is set to come down further.

Also Read: Interest rates are falling. Here's what you need to do

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Impact of the rate cut
The rate cut is expected to reduce EMIs (equated monthly instalments) of borrowers and also make it cheaper to take new loans. Now with the external benchmarking of floating rate loans from October 1, these loans compared to those linked to MCLR will become cheaper. So, for borrowers looking to take loans this festive season, they will get even more attractive rates.

According to RBI's circular issued a month ago in September, the loans can either be linked with the repo rate, three or six-month treasury bill yield or any other benchmark market interest rate published by the Financial Benchmarks India (FBIL).

Further, under the new interest rate regime, RBI has mandated banks to reset rates every three months.

Also Read: How borrowers' EMI will be reset in the external benchmark regime

Here's an example of how your home loan will be impacted under the new external benchmark regime like repo rate.
Loan Amount (₹)

3000000

Tenure (Years)

20

Current Interest Rate (%)

8.20

Current EMI (₹)

25, 468

New Interest rate (%)

7.95

New EMI (₹)

25,000

Cut in EMI (₹)

468

Interest rate on home loan up to Rs 30 lakh from SBI website.

Here's what different types of borrowers can do after today's rate cut.

  • New borrowers
In the present lower interest rate scenario, loans will become cheaper for new borrowers. All new floating rate loans given by banks will be linked to an external benchmark as mentioned above. While taking this type of loan, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the cheapest interest rate.

Also, keep in mind that when RBI starts to hike key rates, your interest rates will go up in tandem.

Also Read: How external benchmark rate regime impact borrowers?

If you are planning to take a home loan, then check if you can avail the benefit of credit subsidy available under the Pradhan Mantri Awas Yojana (PMAY). Middle income group - I (MIG -I) with income between Rs 6 lakh and Rs 12 lakh can avail interest subsidy of 4 per cent whereas middle income group - II (MIG -II) with income between Rs 12 lakh and 18 lakh can get interest subsidy of 3 per cent under the scheme. The benefit of interest subsidy for both the groups is available till March 31, 2020.

Also Read: Everything you need to know about PMAY

Existing borrowers
A) With loans linked to MCLR
With effect from September 10, SBI has reduced the MCLR (marginal cost based lending rate) by 10 bps across all tenors. Other banks such as Axis Bank, Central Bank of India and others have also been reducing their MCLR.

Although the RBI has cut the repo rate five times this year, for those servicing MCLR loans, whether their interest rates will come down or not and by how much will depend on their bank. Added to this, the reduction in MCLR will translate into lower EMIs only when the reset date of your home loan arrives.

Usually, a bank offers home loans with reset period of six months or one year. On the reset date, your future EMIs will be calculated on the basis of the interest rate (bank's MCLR plus margin of the bank) prevailing on that date.

If you want to switch from an MCLR-based loan to an external benchmark one, then you have the option to do so by paying an administrative cost. However, financial planners suggest that one should make a switch only if the interest rate difference between the two is 0.50 per cent or more.

To further reduce your home loan burden, you can prepay some amount. Click here to know how you can prepay.

B) With loans linked to base rate or BPLR
For those borrowers whose home loan is still linked to the base rate or BPLR, then you should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of policy rates in comparison with base rate and BPLR rate-linked loans, as per financial planners.
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