Impact of MCLR Hike on Personal Loan Rates: 5 Key Questions

Knowing the variables affecting personal loan interest rates is essential when applying for a personal loan. Among these, the Marginal Cost of Funds-Based Lending Rate (MCLR) plays a pivotal role. MCLR directly affects the cost of borrowing, making it essential for borrowers to grasp its implications, especially when there's an MCLR hike. In this article, we'll answer five key questions about how changes in the MCLR rate impact personal loans and how you can prepare for these fluctuations.

1. What is MCLR, and how does it influence personal loan interest rates?

MCLR is the minimum interest rate below which banks are not allowed to lend, except in specific cases. Introduced by the Reserve Bank of India (RBI) in 2016, MCLR replaced the earlier Base Rate system to ensure a more transparent and efficient mechanism for interest rate transmission.

The MCLR rate reflects the cost of funds for banks and is determined by factors such as the repo rate, operating costs, and the bank's cost of maintaining cash reserves. Personal loan interest rates are often pegged to the MCLR, especially if they are floating-rate loans. When the MCLR increases, the interest rates on loans linked to it, including personal loans, also rise, resulting in higher EMIs or longer loan tenures.

Also read: Interest Rate on a Personal Loan in India

2. How does a repo rate hike impact MCLR?

The RBI's lending rate to banks, known as the repo rate, has a big impact on the MCLR rate. Banks face higher borrowing costs when the RBI increases the repo rate to combat inflation or stabilise the economy. This increase is usually passed on to borrowers through a hike in MCLR.

For instance, during periods of high inflation, the RBI may raise the repo rate to control the money supply. Banks, in turn, adjust their MCLR upward, making personal loans and other floating-rate loans more expensive. Borrowers with existing loans linked to the MCLR may notice an increase in their EMIs.

3. How does an MCLR hike impact personal loan interest rates?

An MCLR hike directly impacts personal loan interest rates, particularly for loans with a floating rate. When MCLR rises, the interest rate applied to your loan increases proportionately. This change can lead to higher EMIs or an extension of the loan tenure, depending on the repayment terms set by the lender.

Borrowers considering new personal loans during an MCLR hike will face higher borrowing costs. The increased interest rates may require careful financial planning to manage the higher repayment burden.

4. What is the difference between MCLR and EBLR, and how do they affect personal loans?

While MCLR is an internal reference rate set by banks, the External Benchmark-Linked Lending Rate (EBLR) is tied to external benchmarks such as the repo rate or Treasury Bill rates. Both these systems influence personal loan interest rates, but their mechanisms differ.

When the repo rate rises, the EBLR adjusts more quickly since it's directly linked to external benchmarks. MCLR, on the other hand, adjusts gradually as banks recalculate their internal costs. Personal loans linked to EBLR may experience a faster rise in interest rates compared to MCLR-linked loans.

5. How can borrowers manage the impact of an MCLR hike on personal loans?

If you're currently repaying a personal loan or planning to apply for one, here are strategies to manage the impact of an MCLR hike:

• Extend the Loan Tenure: Lenders may offer to extend the loan tenure to keep EMIs manageable during an MCLR hike. While this reduces monthly payments, the longer repayment period may increase the overall interest outgo.
• Make Partial Prepayments: If you have surplus funds, consider making a partial prepayment. This reduces the principal amount and can help offset the impact of higher interest rates.
• Switch to Fixed Interest Rates: For borrowers concerned about fluctuating rates, switching to a fixed-rate personal loan can provide stability. However, this may not be an option for all types of loans or at all times.
• Budget for Increased EMIs: When personal loan interest rates rise, reviewing your budget and reallocating expenses can help accommodate higher EMIs without financial strain.
• Explore Refinancing Options: If another lender offers a lower rate, consider refinancing your loan. However, factor in any processing fees or prepayment charges before making the switch.

Understanding the Broader Impact of MCLR Hikes

MCLR hikes don't just affect personal loans; they have a ripple effect on various types of loans, including home loans, vehicle loans, and business loans. Managing the combined impact of increased EMIs can be challenging for borrowers with multiple loans. Consolidating high-interest debt into a single personal loan at a competitive rate may be a viable solution for some.

Moreover, businesses and individuals must remain vigilant about economic trends and RBI policies to anticipate changes in the lending environment. Staying informed can help borrowers make timely decisions and avoid unnecessary financial stress.

Conclusion

An MCLR hike can significantly impact personal loan interest rates, influencing monthly EMIs and overall loan costs. Borrowers can better navigate these changes and make informed financial decisions by understanding the mechanisms behind MCLR, repo rates, and EBLR.

Whether you're repaying an existing personal loan or considering a new one, it's crucial to monitor economic indicators and adapt your repayment strategy accordingly. With proactive planning and financial discipline, you can minimise the impact of MCLR hikes and continue to manage your personal finances effectively.

Borrow wisely, stay informed, and prioritise financial stability to make the most of your personal loan while navigating the evolving lending landscape in India.