If you are planning to buy a home in India, you might wonder how your home loan's interest rates are determined. You might have heard of terms like bank rate and repo rate, but do you know what they mean and how they affect your home loan?
In this blog post, we will explain the difference between bank rate and repo rate, and how they impact your home loan interest rate and EMI. Having knowledge of repo rate vs bank rate is vital to becoming an informed home buyer.
Repo Rate vs Bank Rate: What are they?
The bank rate and repo rate are two key policy rates used by the Reserve Bank of India (RBI) to regulate the money supply and inflation in the economy. They are also known as benchmark rates, as they influence the interest rates banks, and other financial institutions charge on various loans and deposits.
Repo rate basically denotes the interest rate that the RBI charges commercial banks when it lends them for a short term (usually overnight). The collateral in such cases are government securities. Repo stands for repurchase agreement, which means that the banks agree to sell the securities to the RBI and buy them back at a later date at a predetermined price. Repo rate, or repurchase rate, is usually lower than the bank rate, as it reflects the availability of liquidity in the market. Repo rate is used as a tool to inject or absorb liquidity in the economy.
Bank rate, or commercial bank rate, is the rate at which the RBI lends money to commercial banks without any collateral. It is also called the discount rate or the refinance rate. Bank rate is usually higher than the repo rate, as it reflects the risk involved in lending without any security. Bank rate is used as a penal rate for banks that borrow from the RBI beyond their limit.
Repo Rate vs Bank Rate: How do they affect your home loan?
The bank rate and repo rate affect your home loan interest rate indirectly, as they influence the cost of funds for banks and other lenders. When the RBI changes these rates, it signals its monetary policy stance to the market. A higher bank rate or repo rate means that the RBI is tightening its monetary policy, which means that it wants to reduce the money supply and control inflation. A lower bank rate or repo rate means that the RBI is easing its monetary policy, which means that it wants to increase the money supply and stimulate growth.
When the RBI increases the bank rate or repo rate, it makes borrowing more expensive for banks and other lenders. This reduces their profit margin and forces them to increase their lending rates to maintain their profitability. This means that your home loan interest rate will also increase, as banks pass on their increased cost of funds to you. This will also increase your EMI (equated monthly instalment), which is the amount you pay every month towards your home loan.
When the RBI decreases the bank rate or repo rate, it makes borrowing cheaper for banks and other lenders. This increases their profit margin and allows them to reduce their lending rates to attract more customers. This means that your home loan interest rate will also decrease, as banks pass on their reduced cost of funds to you. This will also decrease your EMI, which is the amount you pay every month towards your home loan.
Bank Rate vs Repo Rate: What should you do?
As a home buyer, you should keep an eye on the changes in bank rate and repo rate, as they affect your home loan interest rate and EMI. You should also compare different home loan offers from various lenders before choosing one that suits your needs and budget. When choosing a home loan, you should also consider factors like processing fees, prepayment charges, tenure, flexibility, etc.
You should also be aware of the type of interest rate that you are opting for: fixed or floating. A fixed interest rate means that your home loan interest rate will remain constant throughout the tenure of your loan, irrespective of any changes in bank rate or repo rate. A floating interest rate means that your home loan interest rate will vary according to the changes in bank rate or repo rate. A fixed interest rate offers you stability and certainty, but it may be higher than a floating interest rate initially. A floating interest rate offers you lower interest rates initially, but it may increase or decrease depending on market conditions.
Conclusion
You should choose a type of interest rate that suits your risk appetite and financial goals. You can also switch from one type of interest rate to another during the tenure of your loan, subject to certain terms and conditions.
