Understanding Concepts of MCLR – Detailed guide!

We all dream of having our own home one-day. Looking at the current real estate market, realising this dream is quite the challenge for most people. With property prices sharply increasing, it is nearly impossible to buy a house without availing a home loan. Home loans offer the financial assistance needed to buy a house, and there are many lenders that offer flexible repayment options to make sure borrowers avoid any repayment struggles.

If you are planning on applying for a home loan, it is important to understand the role of MCLR. Confused? Let us give you the details below.

MCLR – what does it mean?

MCLR stands short for Marginal Cost-based Lending Rate and was first announced in 2016. It is the new benchmark based on which banks are supposed to lend money to borrowers. Before the inception of MCLR, banks used to lend money at a regular base rate. Now, there are 4 components when it comes to MCLR. These are the cost of funds, operating costs, tenure premium, cash reserve ratio (CRR), and the negative carry on CRR. The cost at which borrowing and lending take place is known as the marginal cost of funds.

Reserve Bank of India has made it mandatory for banks to set at least 5 MCLR rates, for overnight, a month, three months, six months, and a year. However, independent banks and NBFCs are permitted to set any number of limits.

How does it work?

If you are looking to apply for home loan with a floating interest rate, your loan will be linked to MCLR. You will get flexible options as banks provide at least five to seven home loan interest rate options that you can choose from.

There are certain terms that are related to MCLR that you need to be familiar with.

  • Tenure premium

This is a premium that is charged by banks for the risk that is associated with providing long repayment tenures. The higher the repayment duration, higher is the risk for a bank. This is why banks charge a certain amount in the form of a premium for covering this risk.

  • CRR

CRR stands for Cash Reserve Ratio, which is a proportion that banks mandatorily need to submit to the RBI in liquid cash. This amount is accounted for negatively since it cannot be used by banks for earning income and does not earn any interest. Under the MCLR, banks are given a certain allowance which is known as Negative Carry on CRR.

  • MCF

MCF is short for Marginal cost of funds and is determined by calculating the borrowings of a bank. Banks borrow funds from numerous sources such as savings accounts, current accounts, fixed deposits, RBI loans, equity, and so on. The rates of interest set on these amounts that the bank borrows are used to calculate the MCF. The MCF includes Marginal cost of borrowing, which takes up 92%, as well as the Return on net worth, which accounts for 8%.

  • Operating cost

It is obvious that banks take on certain expenses such as opening branches, raising funds, paying salaries to their employees, and so on. These expenses that are associated with offering loan products are together included in operating costs. Please note that the cost of providing services is not included as they are recovered through service charges.

If a borrower has applied for a loan with a floating interest rate post 1st April 2016, their loan is automatically linked to MCLR. Even if the loan was taken prior to this date and linked to the base rate, they can always switch it to MCLR.

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