Every time you hear the news about an interest rate cut you would heave a sigh of relief thinking that the next EMI would be less than the current month's. However, the truth is most banks do not immediately pass on the benefits of the interest rate cuts to its existing customers.
So your next month's EMI will be the same and will not change probably until the beginning of the next quarter. At the end of the day you will be wondering why and how your bank has not passed on the interest rate cut on your home loan yet, or fear what repercussions it might have on your budget and about the best option available to you to minimize the impact.
Read on to find out the truth about how change in interest rates work and why a change in rate cut doesn't always mean an immediate lower EMI.
How change in interest rates work
The trend of offering lower interest rate on home loans is not a secret, at least in India. Whenever there is a shortfall in selling home loans or during festive seasons, banks line up to announce home loans at cheaper rate of interest. The idea is to attract maximum new customers at a lower rate of interest.
The new customers will definitely stand to benefit here but at a floating rate of interest the cheap offer just means an increase in interest rate is only round the corner probably till the period mentioned in the 'reset' clause on your agreement. This 'reset' clause is the same reason why the same rate cut for new customers has not been applied to you, an existing customer. So what is this 'reset' clause all about?
What is a 'reset' clause and how it could affect you!
Basically there are two aspects to consider when banks decide to hike or reduce their interest rates for its home loan customers. One, the exact percentage of interest rate cut or increase; and two, the reset clause.
A part of your loan agreement, the reset clause is the actual time period required by the bank from which the rate cuts or hike will be implemented. The rate reset clause could be monthly, quarterly, half-yearly or even yearly.
This means that if a rate cut is announced say sometime in March in the current year for a loan taken by you last November and your agreement mentions about a quarterly reset clause then the next reset dates will be applied only in November, February, May, and August.
Of course, this will vary according to the loan conditions. Hence, the benefit of the rate cut on interest announced in March will be reflected in your EMI only from the month of May and not in March. Moreover, the rate cut benefit will accrue on the principal outstanding from May and not March. For instance, if you have an outstanding loan amount of Rs 10 lakh say in March and Rs 9.50 lakh in May, the new interest rate will apply only on Rs 9.50 lakh.
But why a 'reset' clause is required at all?
The reset clause is required by the banks for ease of calculation and to maintain a confidence in the process. Consider the chaotic scenario where the interest rates on millions of rupees sanctioned in the form of loans are reset on any random day!
The banks will end up with the impossible task of calculating the interest every single day on different loan amounts which could equally affect the borrower. The specific time mentioned in the reset clause to adjust the change in interest rates at regular intervals will help the lender and the borrower ensure an orderly calculation, disbursement, payment and collection.
What can you do to minimize the impact?
Unfortunately, there is not much you could do as a borrower as far as the rate cuts are concerned. In most cases, your loan agreement will not allow you to negotiate on the rate cuts. Also, the banks do not engage in negotiation with the borrowers on this point as their specific products have a specific reset clause.
Probably the one best thing for you to do is negotiate with your bank to reset the clause to every quarter if your agreement has mentioned about a half yearly or in worse cases an annual reset clause. This way you can save the money paid on interest rate.