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03 Feb 25 • 3 min read
What is the Difference Between Base Rate and MCLR Rate in a Home Loan?
When it comes to home loans, one of the crucial factors that determines your monthly payments is the interest rate. Base Rate and MCLR are two of the most common types of interest rates. In this blog, we explain base rate and MCLR concepts, do a comparison of the two, and also tell you how they impact your home loan.
Understanding Base Rate
The base rate is the minimum interest rate a bank can charge on loans. The base rate system became mandatory for banks in India in 2010. It considers the cost of funds, including deposits, operating costs, and profit margins. The base rate is the starting point for charging interest on home loans. Banks add a margin to the final interest rate, such as 2% if the base rate is 6% and 2% if the margin is 2%.
Understanding MCLR
MCLR (Marginal Cost of Funds Based Lending Rate) is the benchmark interest rate used by banks to determine home loan rates. Introduced by the Reserve Bank of India (RBI) in 2016, it is revised periodically based on factors like the bank’s cost of funds, repo rates, and operating costs. Unlike the previous base rate system, MCLR reflects changes in market conditions more accurately. Understanding MCLR helps borrowers track how interest rates may fluctuate and manage their loan repayments accordingly.
Base Rate vs. MCLR: Key Differences
Here are the key differences between the base rate and MCLR.
| Aspect | Base Rate | MCLR |
| Basis of Calculation | The base rate will consider the average cost of funds and other costs of operation for the bank. It is a fixed rate fixed by the bank and is rarely changed. | MCLR considers the marginal cost of funds and is reset periodically. It presents the existing cost of funds and other determinants of loan pricing. |
| Flexibility | The base rate remains constant over time and, hence, cannot adapt itself to changes in market conditions. | The MCLR is taken into account and revised monthly, thereby facilitating its adjustments to changes in market conditions as well as in economic conditions. |
| Transparency | The base rate system is usually less transparent because it remains for longer periods, and thereby the exact relationship of the change in market conditions on interest rates becomes unknown to the borrowers. | The MCLR system, since it gets revised periodically, provides more transparency to the borrower about how their rate of interest is determined. |
| Impact on Borrowers | This system keeps your rate of interest more stable; however, it may not reflect the latest cost of funds or market conditions. | Under MCLR, your rate of interest will change more frequently to market conditions and may lead to a higher degree of fluctuations in your monthly payments. |
Difference in Rate: How Does It Impact Your Home Loan?
In choosing between Base Rate vs MCLR, the rate difference can increase or decrease a high boost to your home loan. If you have a loan that is linked to the base rate, your rate of interest would be stable but not very responsive to changes in the market. A loan that would be linked with MCLR will be much more vulnerable to changes in the cost of funds, meaning your rate of interest can go up and down quite frequently.
For example, if the MCLR rate decreases because of a decline in the cost of funds, then your home loan interest rate decreases, which can reduce your monthly payments. If the MCLR rate increases, so does your interest rate and thereby your payments.
What is the MCLR Rate?
MCLR rate is the rate at which banks lend to their most creditworthy customers. This becomes a standard upon which various types of loans are given. MCLR Rate comprises the following elements:
- Marginal cost of funds: The cost of a fresh acquisition of funds.
- Operating costs: Expenses for running the bank.
- Profit margin: The margin that the bank intends to earn.
- Tenor premium: The premium charged because of the longer tenure of loans.
To arrive at the final interest rate that will be charged to you for your home loan, banks add a spread or margin over and above the MCLR. So, in case the MCLR worked out at 7% and if the bank added 1.5% as margin, then your interest rate would be 8.5%.
Conclusion
Banks use base rate and MCLR techniques to calculate interest rates on home loans. Base Rate remains constant, while MCLR is updated based on market realities and fund costs. Understanding these variations helps make informed decisions about home loans and financial management. Understanding the difference between base rate and MCLR is crucial for new loan applicants or reviewing existing ones, enabling better financial decision-making and meeting financial goals.
FAQs on Base Rate and MCLR Rate
1. What is the full form of MCLR?
MCLR stands for Marginal Cost of Funds Based Lending Rate, by which banks fix the interest rates of loans.
2. How does MCLR differ from the base rate?
MCLR is more often revised from the fixed base rate and is more responsive to market changes.
3. How often is the MCLR rate revised?
The MCLR rate is revised typically on a monthly basis, some banks do it quarterly.
4. What is the rate difference between the base rate and MCLR?
The difference is variable, and MCLR remains mostly lower because it is aligned to the current cost of funds.
5. How does the MCLR rate affect home loan interest rates?
The MCLR rate is the base on which home loan interest rates are set, and thus these rates have been changing periodically.