Repo rate is the rate at which the Reserve Bank of India lends money to the financial institutions in the case of any fund shortage. This rate is a primary tool regarding RBI’s credit and monetary policy.
The repo rate, which is set at 4.0% currently, is also used by monetary institutions to control inflation. Individuals unfamiliar with the question of – what is repo rate can go through the following sections.
A closer look at what is repo rate
The term ‘repo’ indicates repurchase agreement or opinion. When financial institutions face shortage in funds, they reach out to the central bank to secure financing for a certain tenor by submitting treasury bills and government bonds as collateral.
These commercial banks are required to pay interest to the RBI as per the prevailing repo rate. Commercial banks can retain these bonds from the RBI when the tenor ends by repaying a pre-set price.
Repo rate is a crucial monetary tool used by the Reserve Bank of India to control inflation and preserve market liquidity. As a result, depending on the current economic situation, the central bank increases or decreases this rate.
Consequently, any change in this rate directly affects the credit cost for commercial banks. This, in turn, impacts commercial banks’ lending policies, such as home loan interest rate, bank deposit rate, and more.
How does a change in repo rate impact home loans?
Here is how a change in repo rate impacts the home loan sector:
Impact of repo rate cut
To tackle inflation and liquidity in the market, RBI cuts down the repo rate. This repo rate reduction increases cash flow in the economy and increases the availability of funds for the general public.
In simple terms, with a reduced repo rate, commercial banks can borrow funds from the RBI at a lower rate. As a result, when approaching commercial banks, retail borrowers witness a cut in lending interest rates. One of the most significant effects of repo rate reduction is that individuals can apply for a home loan with their respective lenders at a much lower interest rate. This lowers the monthly instalments and the overall loan burden. Resultantly, borrowers are interested in availing a high-value loan quantum, which increases the cash flow, and hence, drives robust economic growth.
Impact of repo rate increase
Individuals wondering about what is repo rate must know that the central bank increases the repo rate to suppress rising inflation. As the repo rate increase, commercial banks have to incur more costs while securing funds from the central bank. As a result, commercial banks tend to levy higher interest rates on loans for retail borrowers. This hike in interest rates limits borrowers from securing funds, resulting in a decreased cash flow in the economy.
This cash flow deduction helps in controlling the rising inflation.
However, repo rate is not the only factor that affects lending interest rates. Competitive loan rates depend upon various factors, including:
Borrower’s financial profile
Lenders modify the interest rate on home loans after assessing the risk associated with a borrower. In simple terms, the more risk a borrower carries, the more will be the interest rate.
Leading lenders determine risks of the borrowers through:
CIBIL score is a measure of a borrower’s creditworthiness. This 3-digit numeric score indicates whether a borrower is capable of repaying the loan amount or not. Resultantly, individuals must try to maintain a high CIBIL score of 750 or more to obtain a loan with a lower interest rate.
Secured financing like home loans are long term commitments. Hence, borrowers need to have a stable job with reputed private or public limited companies or an MNC. To determine income stability, financial institutions ask for salary slips or bank account statements, which a borrower must keep handy.
The property’s location that a borrower aims to purchase plays a significant role in determining the loan’s interest rate. Evidently, houses situated in a good locality with good transport connectivity and other amenities will have a higher resale value. In the same way, newer properties are more valuable according to lenders as old properties offer lesser resale value.
As for lenders, properties with more resale values are lucrative offers; hence they charge a lower interest rate for loans upon such properties. In the same way, older properties will have a higher rate of interest.
To obtain the most affordable financing, individuals must aim to meet the home loan eligibility criteria. Meeting/exceeding the eligibility also provides personalised offers to existing customers. For instance, leading financial institutions across the country extend pre-approved offers, which help in a simplified and fastened loan application procedure. These offers are provided on various financial instruments like home loans and loans against property. You can check your pre-approved offer within seconds by entering your name and contact details.
For prospective borrowers, knowing what is repo rate is crucial, as it is a major determining factor of lending rates. Therefore, staying updated on these fronts and working upon one’s financial history can help borrowers avail affordable financing.