How Repo Rate impacts EMI

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Repo Rate impacts EMI

The following article provides clarity on the topic of repo rate, EMI, and how the repo rate impacts EMI. Does repo rate affect home loan? How does a change in repo rate affect EMI? Such questions which you would surely be wondering about will also be answered in this article.

What is repo rate?

Repo rate is the monetary policy rate of interest at which the Reserve Bank of India offers loans to the commercial banks of India in the case of a monetary shortage. The rate of interest or repo rate is determined by the Governor of the Reserve Bank of India who officiates a meeting of the Monetary Policy Committee (MPC).

There was a recent drop in the repo rate on October 4, 2019, which led to a descent from 5.40% to 5.15%. A further drop in the repo rate on March 27, 2020, has led to it standing at 4.40% currently.

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What is EMI?

EMI is the abbreviated form of the word, 'Equated Monthly Instalments'. When you opt to receive a monetary loan from a commercial bank, you are obligated to reimburse that loan to the bank in terms of monthly payments over a certain period of time. These monthly payments are referred to as equated monthly installments (EMIs). It is the amount of money that you pay back to the back in a month as part of paying back your loan.

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How does repo rate impact EMI?

Repo rate, which is the rate of interest tallied on the loans procured by the commercial banks of India from the Reserve Bank of India, is subject to change from time to time. Change in the repo rate is not an unconventional occurring and it might happen from time to time depending on the decisions taken by the Governor of the Reserve Bank of India in the Monetary Policy Committee (MPC) meetings.

Now, a distinctive change in the repo rate would lead to consequent changes in the equated monthly installments (EMIs) as well. Now how would repo rate impact EMI?

  • If the Reserve Bank of India, which is the Central Bank of India, resolves to reduce the rate of interest on its loans given in favor of the commercial banks, then the same advantage will be conveyed to the clients of the commercial banks. Therefore, the rate of interest on the loans offered by the commercial banks to its customers will also get reduced, which in turn will reduce the amount of the equated monthly installments or the EMIs.
  • Similarly, if the Reserve Bank of India decides to put a raise on the repo rate or rate of interest on the loans that it offers to the commercial banks, the same expense will befall the customers of the commercial banks as well. Hence, repayment of the loans taken by these customers from commercial banks will become expensive, which in turn will hike the amount of equated monthly installments (EMIs) that they are required to pay.

However, according to past observation, it is seen that when the Reserve Bank of India cuts down the repo rate, the commercial banks deliberately take more time to reduce their lending rates which profit their clients by reducing their EMIs.

On the contrary, when the Reserve Bank of India increases their rates of interest on loans, the commercial banks immediately raise their lending rates which in turn raises the equated monthly installments (EMIs) that the customers are required to pay.

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Does repo rate affect home loans?

Now, we will learn about the repo rate effect on home loan. First, let’s focus on what entails the process of purchasing a home with the help of a home loan. For an average individual, owning your own home is a subject of great pleasure and gratification. It gives you a sense of accountability and humility. Purchasing your own home is not necessarily an inexpensive process. Often, people choose to opt for a loan from a commercial bank to assist in their purchase by funding the required monetary amount. This is referred to as a home loan.

A home loan is a monetary solution offered by most commercial banks that allows you to avail of a financial loan amount which in turn allows you to purchase your dream home with ease. However, the interest rate on the amount you loan from the commercial bank plays a vital role in your decision to opt for a home loan. This rate of interest is regulated based on your ability to reimburse the money you loaned as well as the repo rate set up by the Reserve Bank of India. 

At present, the rate of interest on the home loans provided by the commercial banks is concurrent with an external benchmark. The Reserve Bank of India has instructed the commercial banks to link their market lending interest rates to a set of external benchmarks set up by the Reserve Bank of India itself. Most of the commercial banks of India have decided to opt for the Repo rate of the Reserve Bank of India as their external benchmark.

Potential home-owners generally choose a home loan plan that has a fluctuation rate of interest. A small surge or reduction in the interest rates may result in a substantial impact on the cost of the property. A home loan typically has a long-term timeline which is about 20 years. Hence, any change in the rate of interest within this extended period of time will have a significant effect on the subscriber's reimbursement to the bank. The repo rate effect on home loan can be well explained by giving you an example of the current situation.

The Reserve Bank of India has recently declared a drop in the repo rate of interest which has resulted in the repo rate to fall from 4.4% to 4%. Now, this 4% is the rate at which the Reserve Bank of India offers loans to the commercial banks. Now, for customers that have purchased home loans after October 1, 2019, or have changed to the external benchmark routine, this occurrence inevitably renders a distinct reduction in the interest rates of their home loans.

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How does a change in repo rate affect EMI?

As has already been explained above, a change in the repo rate, which is the rate of interest at which the Reserve Bank of India offers loans to the commercial banks, will lead to a significant change in the equated monthly installments (EMIs) that is paid by the clients of the commercial banks as reimbursement of loans taken from the banks.

A rise in the repo rate of the Reserve Bank of India will lead to a surge in the rate of interest offered by commercial banks to their customers. This will cause an increase in the equated monthly installments (EMIs) that the customers pay to the commercial banks. Similarly, a fall in the repo rate of the Reserve Bank of India will lead to a fall in the interest rates offered by commercial banks. This will result in a reduction in the rate of equated monthly installments (EMIs) that the customers have to pay to the commercial banks.

The former situation acts as an inconvenience to the commercial banks as well as their customers, while the latter situation acts as an advantage for both the commercial banks as well as their clients.

What do you mean by RBI’s repo rate cut mean for loan?

A rate cut in the repo rate of the Reserve Bank of India means a fall in the rate of interest it tallies on the loans that it offers to the commercial banks. A fall in this repo rate significantly affects the rate of interest of the loans that the commercial banks offer to its customers.

Any reduction, small or large, in the repo rate of the Reserve Bank of India has a substantial impact on the commercial banks as well as its clients. Even the smallest drop in the repo rate of the Reserve Bank of India will lead to a drop in the interest rates of the loans that are offered by the commercial banks, which in turn will result in a reduction in the amount that their customers have to compensate as equated monthly installments (EMIs). This is rendered as beneficial to the customers as they are compelled to pay lesser amounts.

Frequently Asked Questions (FAQs):

  • What is reverse repo rate?

As the name suggests, it is the opposite of the repo rate. Reverse repo rate refers to the rate of interest at which the Reserve Bank of India itself takes loans from other banks for a short timeline.

  • What does the repo rate cut mean for banks?

A repo rate cut basically means that the commercial banks can borrow funds from the RBI at cheaper rates of interest.

Conclusion:

This article can be concluded on the notion that any change in the repo rate will result in important changes in the rate of interest on the loans offered by commercial banks. The question of how would repo rate impact EMI has also been addressed and answered. Repo rate effect on home loan has also been discussed in the above article.

Also read: Repo Rate Impact on Home Loan