Base rate - Understand why your EMI will not change

Starting July 1, all banks in India will be moving to a "base rate" regime. What does this mean for you and
how does it affect your existing borrowings? Here we help clarify some of these questions.

What is the base rate?

When you borrow money to buy a house or car or electrical appliance, there is an interest rate that you have to pay to
the lender. The base rate is the minimum rate that a bank will lend money at. Think of it as a floor below which RBI
will not allow banks to lend to you.

Previously, banks used to price the loans they offered you on a complicated system called benchmark prime lending
rate (BPLR). Each bank has its own BPLR methodology which made it difficult for borrowers to compare rates across
banks. Now, with the base rate in place, it will be easier for all of us to compare across banks and to get a more
transparent sense of how the interest rate for the loan is being arrived at.

Is my interest rate going to be cheaper? Will my EMI change?

The most important thing to keep in mind is that the cost of money is not changing, i.e., if your car loan cost about
12% or home loan cost 9%, this rate of interest charged to you will be no different going forward. Its just that the
method used to arrive at this will be more clear to you. So, interest rates aren't coming down as a result of this base
rate implementation.

Following on from this, your EMI on an existing loan is also not going to change. You will continue to pay whatever
you were paying up to last month in future months as well.

Should I change to a bank with a lower base rate?

Like we said above, the cost of money is not changing. Most banks will continue to charge you a very similar rate of
interest as they did before. Just because one bank has a base rate of 7.5% and another has a rate of 8% does not
mean you should switch to the bank with the lower rate. On top of this base rate will be added an additional amount
of interest that they bank will charge you to cover its cost of doing business with you, and some compensation for the
risk its taking in lending to you. So, after all these additions, its unlikely that the lending rate that a bank will be
charging to you will be any different to the rate being charged by your current bank.

You will see no major advantage to shifting from one bank to another.

How does the base rate affect my pre-existing loan?

Nothing is going to change for existing loans. They will continue as is. Like we mentioned above, interest rates aren't
changing in the economy. However, when your loan comes up for renewal, then it will be priced using the base rate
formula.

Will the base rate remain fixed forever?

No, the RBI has given guidelines to banks to adjust their base rates depending upon the prevailing market conditions
and interest rate policies. Expect to see banks update their base rates every few months if that is required. Banks will
then communicate this to all their clients.

By www.iTrust.in - India's leading one-stop financial supermarket for real estate, home loans, investments, taxes and
financial planning.