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Key Highlights
- MCLR is based on the marginal cost of funds, while Base Rate considers the average cost of funds.
- MCLR includes a tenure premium for longer-term loans but Base Rate does not factor in loan tenure.
- Banks must publish MCLR in loan for different tenures, making it more transparent than the Base Rate.
- MCLR is revised monthly, while the Base Rate could be changed quarterly, making MCLR more dynamic.
- Loans linked to MCLR are more responsive to changes in the RBI's policy rates compared to Base Rate loans.
When you're looking to take out a loan, especially a home loan , it's important to understand how banks calculate the interest rates they offer. In India, there are two main benchmarks that banks use: the Base Rate and the Marginal Cost of Funds based Lending Rate, or MCLR.Although these two benchmarks might seem similar, some significant differences between them can impact the interest rate on your loan. Let's find out more.
What is Base Rate?
The Base Rate system was introduced by the Reserve Bank of India (RBI) in 2010. It replaced the Benchmark Prime Lending Rate (BPLR) and set a minimum rate below which banks were not allowed to lend, except in certain cases.To calculate the Base Rate, banks considered factors like:
- Average cost of funds
- Operating expenses
- Minimum rate of return (profit margin)
- Cost of maintaining Cash Reserve Ratio (CRR)
Under this system, banks had some flexibility in determining their cost of funds. They could change their Base Rate every quarter.
What is MCLR?
In April 2016, the RBI introduced the Marginal Cost of Funds based Lending Rate (MCLR) to replace the Base Rate system. Like Base Rate, MCLR acts as a benchmark rate below which banks cannot lend.However, bank MCLR rates is calculated differently, based on:
- Marginal cost of funds (92% based on marginal cost of borrowing, 8% on return on net worth)
- Operating costs
- tenure premium (for loans with longer tenures)
- Negative carry on account of Cash Reserve Ratio (CRR)
Banks must publish their latest MCLR rates for different tenures, ranging from overnight to one year. Also Read: Everything about the Base Rate in a Home Loan
5 Key Differences Between MCLR and Base Rate
Now that we understand the basics of MCLR vs Base Rate, let's look at the five main differences between these two benchmarks:
Calculation Method
The Base Rate was calculated using the average cost of funds, minimum rate of return, operating expenses, and the cost of maintaining CRR and Statutory Liquidity Ratio (SLR).In contrast, the MCLR calculation is based on the marginal (incremental) cost of funds, operating costs, tenure premium and negative carry on CRR only. SLR is not considered.
Cost of Funds
Under the Base Rate system, banks could consider average, marginal or blended cost of funds.
With MCLR, banks can only consider the marginal or incremental cost of funds, which is more dynamic.
Tenure Premium
The Base Rate did not factor in the loan tenure when calculating interest rates. All loans, regardless of duration, were priced using the same Base Rate.MCLR, however, includes a tenure premium. This means banks can charge higher interest rates for loans with longer tenures, to account for the higher risk involved.
Revision Frequency
Banks were allowed to revise their Base Rate every quarter.In contrast, banks must revise their MCLR rates every month. This makes MCLR more dynamic and responsive to changes in the cost of funds.
Transparency and Transmission
The Base Rate system lacked transparency, as banks had flexibility in calculating the cost of funds and there was no standardized formula.MCLR follows a more defined formula set by the RBI, which improves transparency. It is also more responsive to changes in the RBI's policy rates, leading to better transmission of monetary policy.
Make an Informed Decision
Understanding the difference between Base Rate and MCLR is a great starting point in your loan journey. But there are a few more steps you can take to make an informed decision:
- Assess your current loans , if any. Check whether they are linked to Base Rate or MCLR, and compare the interest rates with current offerings.
- Use online MCLR calculators to compare rates from different banks. Factor in the reset period and any additional charges.
- Negotiate with banks . Many banks offer discounts on their published current MCLR rates, especially for borrowers with good credit scores.
- Consider the long-term impact . While a lower interest rate is important, also look at factors like loan tenure, processing fees, and prepayment charges.
- Seek expert advice . Consult with a financial advisor or loan expert who can help you understand the nuances of MCLR vs Base Rate and choose the best option for your needs.
By taking these steps, you can ensure that you're getting the best possible deal on your loan and making a decision that supports your long-term financial well-being. Also Read: Understanding Repo Rate: What It Means for You?
FAQS - FREQUENTLY ASKED QUESTIONS
What does MCLR stand for?
MCLR stands for Marginal Cost of Funds based Lending Rate. It is a benchmark lending rate introduced by the Reserve Bank of India in April 2016.
How is MCLR different from the Base Rate?
MCLR is based on the marginal cost of funds, includes a tenure premium for longer-term loans, and is revised monthly. Base Rate, on the other hand, considered the average cost of funds and did not factor in loan tenure.
Which is better, MCLR or Base Rate?
MCLR is generally considered better as it is more transparent, responsive to policy rate changes, and allows for differentiated pricing based on loan tenure. However, the best option for you depends on your specific loan requirements.
Can I switch my loan from Base Rate to MCLR?
Yes, many banks allow borrowers to switch their loans from Base Rate to MCLR. However, you should carefully evaluate the costs involved, such as processing fees, and ensure that the savings in interest outweigh these costs.
How often do banks revise their MCLR rates?
Banks are required to revise their MCLR rates on a monthly basis. This makes MCLR more dynamic and responsive to changes in the cost of funds compared to Base Rate, which could be revised quarterly.
What factors influence MCLR?
MCLR is influenced by factors such as the marginal cost of funds, operating costs, tenure premium, and negative carry on account of Cash Reserve Ratio (CRR).
Do all banks offer loans linked to MCLR?
Yes, all banks in India are required to offer loans linked to MCLR as per the Reserve Bank of India's guidelines. However, the specific MCLR rates may vary from bank to bank.
What is the difference between MCLR and repo rate?
The repo rate is the rate at which the RBI lends money to commercial banks. MCLR is an internal benchmark rate used by banks to determine lending rates for their customers. Changes in the repo rate can influence MCLR, but they are not the same.
How can I compare MCLR rates from different banks?
You can compare MCLR rates from different banks by visiting their websites or using online MCLR comparison tools. Be sure to consider factors like the reset period and any additional charges as well.
What is the reset period in MCLR-linked loans?
The reset period is the frequency at which the interest rate on your MCLR-linked loan is revised. It could be monthly, quarterly, half-yearly, or annually, depending on the loan agreement.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
