RBI rate hike to make home, car loans costlier

Borrowers of home, car, and personal loans in India will face higher costs following the Reserve Bank of India's (RBI) decision to raise its policy rate by 25 basis points to 5.50% on Wednesday. This marks the central bank's first increase in borrowing costs since February 2023.

The monetary policy committee voted unanimously for the rate hike and adopted a "calibrated tightening" approach. RBI Governor Sanjay Malhotra stated that further rate cuts are not on the table for now, leaving the future rate decisions open for either an increase or a pause.

The impact on existing borrowers depends on the benchmark on which their loan agreement is based. Banks are required to reset rates on loans linked to external benchmarks at least once every three months. Therefore, external benchmark-linked home, car, or personal loans could become more expensive at the next reset if the banks pass on the full increase. However, fixed-rate loans are not affected by this decision.

The majority of floating-rate rupee loans linked to external benchmarks accounted for 68.2% of banks' outstanding loans at the end of June, according to the latest RBI data. Another 29.6% of loans were linked to banks' marginal cost of funds-based lending rate (MCLR). The exposure to higher borrowing costs will be significant for these borrowers.

Banks' home loan rates currently start at 7.25% per annum. The actual rate borrowers pay, and when it changes, will depend on the loan's terms and the bank's subsequent rate revision. MCLR-linked loans, including some MSME loans and corporate borrowing, will be affected later when their rates change on the reset date specified in the loan contract, while the bank's MCLR itself responds to changes in its funding costs.