The Reserve Bank of India's monetary policy committee announced a revised repo rate of 4.00 percent and a reverse repo rate of 3.35 percent, both effective December 2020. The repo rate has decreased by 115 basis points since March 2020. We frequently hear about the RBI decreasing or raising the repo rate by a particular number of basis points. When these rates fall, it's always excellent news for commercial banks. So, how does it effect your EMI and how can you benefit from it?
Before we look at how it affects your EMI, let's look at how repo rates and EMIs work.
What is the repo rate?
When commercial banks in India are low on cash, they turn to the Reserve Bank of India for assistance. The interest rate charged by the RBI to commercial banks when they lend money is known as the repo rate. Monetary authorities utilise this rate to keep inflation under control.
The central bank may raise the repo rate if inflation increases. This is done to deter commercial banks from borrowing funds, so limiting the amount of money in circulation and lowering inflation. The central bank may now reduce the repo rate if inflation falls. This serves as a motivator for commercial banks to take out loans. They will subsequently distribute these monies to their consumers, boosting the money supply.
READ MORE: Here are 5 ways you can opt for reduced EMIs on home loans.
What exactly is EMI and how does it work?
You must repay a bank loan in monthly instalments if you take one out. An Equated Monthly Instalment is the name given to each payment (EMI). The principal and interest make up every EMI. The majority of the interest is normally collected in the first half of your term by banks. That's why your EMI includes a high interest component while you're repaying a loan at first. As you get closer to the end of your loan term, your EMI will start to include a bigger principal component.
READ MORE: How to ensure that surging EMIs don’t spoil your monthly budget
EMIs and Repo Rate: What’s the relation?
A low repo rate, in theory, should imply low-cost loans for the general public. The RBI expects banks to cut their loan interest rates when it lowers the repo rate. This means that the interest rates on the loans supplied to clients are lower, lowering the EMI.
Similarly, when the repo rate rises, the cost of client borrowing rises dramatically. This is due to the fact that commercial banks must purchase funds from the central bank at greater prices, forcing them to raise lending rates.
This isn't always the case, though. When the Reserve Bank of India lowers its interest rates, it takes time for banks to lower their lending rates. Banks, on the other hand, are eager to raise their lending rates when the repo rate rises.
As a result, the RBI implemented the MCLR regime in the goal of transforming how commercial banks operate. Banks must now announce new interest rates at least five times every month. In addition, the spread that they can apply to their base rate is subject to stricter controls. A 25-basis-point cushion above the MCLR is allowed for banks. The repo rate and the EMI may have a stronger link under the new MCLR system than they did previously.