Home Loan- Get Benefit By Shifting To Base Rate

Base Rate is one of the reforms on banking system by RBI to reduce the lending risk for banks. Before setting the base rate system, banks used Prime Lending Rate (PLR) to set their lending rates. RBI come up with the new Base Rate system where banks can lend the loans based on the new rating system. Banks have given their existing customers the options to shift their benchmark rate to the base rate. Base Rate System has many advantages over the older method of Prime Lending Rate (PLR).

Advantage of Base Rate

Normally the banks can not lend the money below the PLR but to lure the customers, banks started offering the loans cheaper than the PLR which put the extra burden on the borrowers. RBI come up with the new base rate system where every bank has to declare to the public how they have calculated the base rates. This provides more transparency to compare interest rates offered by various banks.

Banks have given their existing customers the options to shift to the base rate from the existing system of benchmarking against the PLR. The RBI has asked banks not to charge any fee for shifting from prime lending rate to base rate. Once you have shifted to the latest rate, this along with the linkage with base rate will ensure that future costs are saved.

Benefit by Shifting

The borrowers can shift to the base rate from the existing system of PLR. In Base rate system as the banks are supposed to visit their base rates every three months, they will have to cut their base rates if interest rates in the market fall. As all the variable rates of interest are pegged against the base rate, the existing borrowers will also be benefited by any cut in the base rate. The base rate is fixed on the basis of various costs that a bank incurs in mobilizing funds and is a more transparent system.

When a person shifts to base rate, the interest is likely to remain the same. Shifting early to the new benchmark would only help to get the benefits earlier. And if the existing loan rate is around 1-2 per cent lower than your existing rate, it makes sense to renegotiate as well. The bank says the margin would be adjusted accordingly to maintain the effective current interest rate. Assume you have a home loan of Rs 20 lakhs and the current effective rate of interest of 12 percent, now, with migration to base rate as the benchmark, your rate of interest will continue to be 12 percent (7.5 percent the base rate plus 4.5 percent margin). The bank has fixed its base rate at 7.5 percent.

In the new base rate system, if the interest rates fall, banks will have to lower the base rate, which is a function of cost of funds in the market. As all the variable rates of interest are pegged against the base rate, the existing borrowers will also be benefited by any cut in the base rate. Therefore, it is advisable for the existing borrowers to opt for the base rate as their benchmark rate.

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