Home Loans To Become Cheaper With RBI's Repo Rate Cut

The Reserve Bank of India (RBI) cut the repo rate by 25 basis points on June 2, 2015. This is the third rate cut by the RBI in 2015. In January and March, the RBI had cut the repo rate by 25 basis points each. In 2015, the repo rate at which the RBI lends to commercial banks has declined from 8 to 7.25.

When the RBI cut the repo rate in January, most banks had not cut their home loan interest rates. After the RBI cut the interest rate further in March, banks were still hesitant to cut home loan interest rates, though some nationalized banks did. But, banks fell in line when the RBI governor Raghuram Rajan urged them to cut rates. On April 7, leading banks like SBI, HDFC and ICICI cut the interest rates by 20-25 basis points. 

After the RBI cut the repo rate in June, SBI announced that from June 8 onward, its base lending rate would fall from 9.85 to 9.7%. Allahabad Bank announced a base lending rate cut of 30 basis points while Dena Bank, Punjab & Sind Bank cut rates by 25 basis points each. This is a remarkable decline in interest rates.

As the leading banks have announced rate cuts, home loans will soon become cheaper. Most home buyers in India take home loans at a floating interest rate. Their interest rates would fall when the banks cut interest rates. But, as most banks cut the tenure instead of the interest rate, home loan tenure is more likely to fall. Even though the fall in interest rates would be modest, in the long run, individuals who own apartments in India will save a significantly large amount of money on interest rate payment in the long run.

According to a survey of Reuters, the RBI is not likely to cut the repo rate anytime soon, except in the fourth quarter, after taking into account the effect of Monsoon on food prices and the interest rate policy of the US Federal Reserve in September. But, home loan interest rates are very likely to fall in the next few years, because the RBI decided to have a formal inflation target for the first time in the 80 years of its existence.

Most developed countries have a formal inflation target. Even though the US Federal Reserve did not have a formal inflation target till recently, it had an informal inflation target. In countries with formal inflation targets, inflation rates are in the range of 2-3% often. If inflation levels fall to such low levels in India, the RBI would be more comfortable cutting the repo rate. This is quite possible because inflation in April 2015 was 4.87% and the WPI inflation was -2.65%. India has rarely seen such consistently low inflation levels. When inflation falls to the level seen in developed countries, home loan interest rate would fall substantially.