Mortgage rates linked to repos can be volatile

MUMBAI: Mortgage loans linked to the repository have drastically reduced borrowing costs for the client. For example, OSE 's mortgage loan the rate fell to 8.05% after linking its advances to the repo rate which is almost half a percentage point lower than 8.55% that charged customers in June below the marginal cost of the interest rate (MCLR).

What makes the product more attractive is that RBI It is very likely to reduce rates further given the economic slowdown. Any such reduction will be transmitted to the borrower in three months, since the rate is reset every quarter. In addition, if the review is applicable on a particular date, banks will calculate interest on a pro rata basis.

But like all products, an external benchmark such as the repository has its disadvantages.

This includes the risk of increased volatility compared to MCLR. In addition, banks have structured loans to protect their interests, which could mean an installment review.

In the case of repo-linked mortgage loan s while the cost of the loan may come down over the years, the EMIs may not drop proportionately. OSE has said that the loan repayment is such that at least 3% of the principal is repaid every year. This is unlike most long-term mortgage loan s where the lenders end up collecting largely interest in the initial years. This means that EMIs could be higher or fluctuate during the year.

The other risk is that of volatility. Although the repo is now a signalling tool for the RBI, in the past the central bank has used the repo to manipulate liquidity in the system particularly at times when the rupee has come under pressure.

If in future RBI decides to choose the repo rate to suck out liquidity from markets to defend the rupee, home-loan customers could experience high volatility in their repayments. The historic low for the repo rate is 4.75% which is 65bps lower than the current rate of 5.4%. The historic high is however 9% which is 360 bps higher than current rates.