A home loan interest rate reset clause allows the lender to review the interest rate after a certain period, as per the occurrence of a scheduled reset date of the loan.
A reset rate is the new interest rate that a borrower must pay effective from the scheduled reset date. The lender will provide details on a loan’s reset terms and interest rate calculations in the borrower’s credit agreement.
In the case of home loans, banks generally offer either of the following options: Floating Rate Home Loans and Fixed Rate Home Loans.
The EMI of a floating rate loan changes with periodical changes in reset interest rates. The floating interest rate is made up of two parts: external benchmark (like RLLR) or internal reference rates the MCLR. These rates are not uniform in all the banks as the cost of funds differs from bank to bank. The spread/Mark-up is an extra amount that the banker adds to cover credit risk, profit mark-up, etc. This is also not uniform in all the banks. So the interest rates on various types of loans and advances are different in different banks.
The rate of interest on fixed-rate home loans is fixed either for the entire tenure of the loan or a certain part of the tenure of the loan. In the case of interest rate on a home loan for the entire tenure of the loan, there is no reset clause and the EMI due to the bank remains constant throughout the tenure of the loan. However, if a bank offers a Loan that is fixed only for a certain period of the tenure of the loan, the bank would reset the rate at the market-adjusted interest rate after the lock-in period at a regular interval as per the reset clause. Therefore, a borrower who opts for a fixed-rate home loan gets clarification from the lender whether the fixed rate of interest is for a limited period or for the entire tenure of the loan.
Re-set period for MCLR linked loans: Even though the banks are supposed to declare overnight, monthly, half-yearly, yearly MCLR, in the case of home loans most banks link their loan to the bank’s 12-month MCLR, while few link to 6-month MCLR as well. This will be the re-set period of the home loan. If a borrower chooses a 12-month period, the home loan (and hence the EMI’s) will be reset at the end of 12 months. In the case of a 6-month period, it will be reset after 6 months.
Since October 1, 2019, RBI has mandated banks to offer retail loans such as home and auto loans linked to an external benchmark, which for most banks is the RBI repo rate (RLLR) (Click here to know what are BPLR rate, MCLR rate, and RLLR rate). Every time, RBI revises the repo rate, the revision in the interest rate is much quicker for the borrower compared to the loans linked to MCLR. RBI announces the Repo rate in its bi-monthly policy rate based on an assessment of the evolving domestic and global macroeconomic and financial conditions and the outlook. Whenever the Repo rate is reduced or increased by RBI, the RLLR has to be reduced or increased by the lender. For example Repo rate is 4%, interest will be charged at 6.50% i.e. {Repo Rate (4.00%) + Mark-up* (2.50%)}
*Note: Banks are free to decide the mark-up or spread over the external benchmark (like RLLR) or internal reference rate (MCLR) for banks to determine the interest they can levy on loans.
All-new floating rate personal or retail loans (housing, auto, etc.) will be according to the prevailing (MCLR or RLLR rate) + Spread. However, in the case of existing floating rate Personal or Retail loans (housing, auto, etc.), the new interest rate (Revised interest rate) is applicable from the scheduled reset date. For example, a bank revises its MCLR from 6.90% to 7.00% effective from December 1, 2021, and spread over MCLR is 2.50% for its home loans. If the reset date of a borrower’s loan is January 1, 2022, the revised interest rate of 9.50% p.a. is applicable to his loan, only from January 1, 2022 (not from December 1, 2021) at the revised interest rate of 9.50%.
