What is Home Loan Repo Rate and Its Effects on Real Estate

One of the key roles of a central bank in any country is to use its monetary policy or a set of guidelines to curb inflation and stabilise the liquidity in the country. This allows the prices to remain stable and curb sharp economic fluctuation. One of the ways this is implemented in India is by the repo rate.

Understanding Repo Rate 

The Reserve Bank of India (RBI) is India's central bank, and it determines the repurchase rate or the repo rate. Simply put, it is the overnight lending rate at which RBI lends money to the commercial and retail banks of the country. So, when the repo rate is high, the banks are less inclined to borrow money from the central bank, and the liquidity in the market is low.

When the repo rate is reduced, the lending goes up and the liquidity increases. This is an instrument for the central bank to control liquidity in the market. The reverse repo rate is the rate at which the RBI borrows from commercial banks in the country.

While it is easy to understand from an economic perspective, let us see how in the case of home loans, repo rate changes impact personal finances.

The Impact of Repo Rate on Home Loans

As mentioned, when the RBI raises its repo rate, commercial banks pay more for borrowing funds overnight. How does it impact regular people like us? Most of us are part of the formal banking system. We maintain bank accounts, invest with banks, and take out loans for financing our property purchases. When the bank's borrowing rate is higher, this additional expense is recovered by increasing the lending rate on all banking finances. This means the rate of interest that the bank charges on its loans and finances also increase when the repo rate goes up.

Repo rate and floating interest rates

Now it is important to understand that the average bank offers two kinds of interest to any home loan borrower – fixed interest and floating interest. Fixed is a regular percentage of interest that is paid over the entire loan term. Floating interests change from month to month depending on the current rates offered by the bank. If the borrower believes that the repo rate may be lowered by the RBI in the future, then the bank's lending rate may be reduced, and, in these cases, a floating rate is a better choice. If the borrower's analysis leads them to believe that interest rates may go up in the long term, then a fixed rate is a good option. So, in the case of home loans, repo rate increase impacts the floating rates.

Current Scenario

The RBI has endeavoured to curb inflation and price fluctuations in the country by increasing the repo rate. In May 2022, the repo rate was pegged at about 4%, and as of the last hike in February 2023, the repo rate currently stands at 6.5%. This means that home loan interest rates are also high. Budget housing sales may dip with an increase in home loan repo rates, but this is unlikely to affect the luxury housing segment.

Conclusion

If you are a prospective home buyer, it is a good idea to consult a financial advisor and seek an opinion on any possible changes to the repo rate in the future. This will impact your EMI outflow and your financial outlay each month.