RBI Monetary Policy: Key points, home, car loans to pinch pockets

The six-member Monetary Policy Committee (MPC) of the RBI voted 5-1 to up the policy repo rate by 50 basis points (bps) to rein in the above target inflation

Hyderabad: The six-member Monetary Policy Committee (MPC) of the RBI voted 5-1 to up the policy repo rate by 50 basis points (bps) to rein in the above target inflation and address concerns around weakening of the currency. Five out of six members voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward.

Big changes

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Since May 2022, the repo has been cumulatively raised by 190 basis points.

May 4 – up from 4% to 4.40% (up 40 basis points)
June 8- up from 4.4% to 4.9% (up 50 bps)
August 8- up from 4.9% to 5.4% (up 50 bps)
September 30 – up from 5.4% to 5.9% (up 50 bps)

Before this, the repo rate was increased on August 1, 2018. However, the reverse repo rate remains the same at 3.35%.

What is repo rate

Repo rate, also referred as repurchase rate, is the rate at which banks borrow from the RBI for meeting short-term fund requirements to maintain liquidity. RBI uses it as an instrument to regulate the liquidity, inflation, and money supply of the nation. A higher repo will slow down the money supply and investment activities in the economy, which is instrumental in controlling the inflation rate.

When is repo rate increased?

High inflation
Depreciating rupee
Speculations in areas of foreign exchange
Possibility of formation of asset bubbles as a result of an excessive amount of capital formation

What is reverse repo rate?

RBI maintains a balance in the market by employing repo rate and reverse repo rate. The reverse is the rate at which RBI borrows money from banks in the short term. The reverse repo rate change will be changed when RBI assumes both inflation and fiscal deficit are well controlled and there is no unlikely possibility that a demand-led price surge. It will be changed when RBI looks to accelerate the economy by facilitating a more friendly monetary policy.

Home loans

The increase in the repo rate will affect the home loans, car loans and other retail loans. For instance, home loans are priced about 250-275 bps higher than the repo rate. At the new repo rate of 5.9%, the home loans will start 8.4% to 8.65%. The rate varies with the bank and the customer profile.
Deep impact

According to Adhil Shetty, CEO, BankBazaar.com, if someone borrowed at 7% for 20 years, the per lakh interest is Rs 86071.74. For a Rs 25 lakh loan, the interest payable is Rs 21.51 lakh. The per lakh EMI is Rs 775.3. For a loan of Rs 25 lakh, the EMI would work out to Rs 19,382.

If the rate went to 8.4% after paying three EMIS, 237 EMIs will be left. Assuming the same EMI of Rs 775.30, the tenure increases to 327 months. This is an addition of 90 months or 7.5 years. The tenure can reduce to 237 months again on an immediate pre-payment of 13 times the EMI or three pre-payments of 4.5x of EMI once every 12 months has roughly the same effect on the tenure.

If the rate goes to 8.9% after 3 months, at the same EMI of Rs 775.3, the tenure now increases to 410 months. This is an addition of 173 months or nearly 14.5 years. But if an immediate pre-payment of 17 times the EMI is made, the tenure again reduces to 236 months. Four pre-payments of 4.5 times the EMI once every 12 months also have the same effect. Focus should be on pre-payment.

Even as the tenure hits 410 months, the loan taking customers would have passed the age of 65. So along with the tenure adjustment, the EMI will also increase. The threshold age limit varies from lender to lender.

The biggest dent will be for those who borrowed at 6.50 to 7%. For those who borrowed at a sub-7 rate, a 20-year loan suddenly becomes a 30-year loan. If someone had taken a loan at 9% around 2018, they would still have benefited from the dip of interest rates into the sub-8 and sub-7 rates. So now, even if the rate goes back to 8.5, they are better compared to when they started.