What is Repo Rate and How Does It Affect Loans in India?

In India, the repo rate is one of the most discussed terms in banking and finance. It plays a crucial role in shaping the economy and directly impacts your loans and EMIs. In January 2024, RBI set it as high as 6,5%, affecting millions and crores of people nationally. 

But what is this repo rate, and how does it affect the decision-making regarding personal loans in Bangalore? Let’s understand. 

Repo Rate: The Basics

The repo rate is the interest rate at which the RBI lends money to commercial banks when they require funds to meet short-term liquidity requirements. It is like the rate banks pay to borrow money from the RBI.

For Instance,

If the repo rate is 6,5%, the banks borrow funds from the RBI at this rate.

A higher repo rate makes borrowing expensive for banks, while a lower rate makes it cheaper.

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How the Repo Rate Impacts Loans

1. Impact on Loan Interest Rates

  • The repo rate is directly proportional to banks’ interest rates on loans.
  • When the repo rate rises, banks transfer the cost to customers by increasing interest rates on home, car, and personal loans.
  • When the repo rate falls, loan interest rates usually decline, making EMIs cheaper.

For example, if you have a ₹20 lakh home loan at a 7% interest rate for 20 years, a 0.5% increase in the rate can raise your EMI by ₹1,000.

2. Impact on EMI Payments

Changes in the repo rate directly affect your monthly budget. Higher rates translate to higher EMIs, and lower rates translate to saving more. 

Here’s how a change in the repo rate affects a ₹10 lakh loan for 5 years:

Repo RateInterest RateEMI (₹)
6.5%7.5%20,028
7.0%8.0%20,278
6.0%7.0%19,783

3. Fixed vs. Floating Rate Loans

  • If you have a floating-rate loan, your interest rate and EMI will vary with changes in the repo rate.
  • The repo rate does not affect fixed-rate loans, but fixed-rate loans do have higher introductory interest rates.

Repo Rate and Inflation: A Balancing Act

The RBI employs the repo rate to regulate inflation:

  • If the RBI wants to lower inflation, it increases the repo rate, which increases the repo rate, which increases the cost of loans and reduces spending.
  • If the RBI wants to increase economic growth, it lowers the repo rate, which increases borrowing and spending.

Why Should You Care About Repo Rate Changes?

If you plan to take a loan, keep an eye on repo rate announcements. A lower repo rate could save you thousands in interest. And for existing borrowers, repo rate changes can directly impact your monthly expenses. A statistic can help better understanding.

According to the RBI’s Monetary Policy Report, a 0.25% change in the repo rate can impact GDP growth by 0.15% to 0.25% over time. 

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Practical Tips for Borrowers

1. Select Loans Wisely: Select a floating-rate loan when repo rates are likely to come down.

2. Refinance When Rates Fall: If the repo rate falls substantially, it is time to refinance your loan to save on EMIs.

Conclusion

The repo rate is not just a technical banking term; it is something that impacts your borrowing costs, your monthly budget, and your financial health in general. Knowing how the repo rate works helps you make smarter financial decisions whether in choosing the right loan or planning your expenses.

Stay informed about RBI announcements to take advantage of shifting repo rates. A little knowledge goes a long way toward better money management!

Frequently Asked Questions

Q. How does the repo rate affect my loan interest rates?

If the repo rate rises, so do loan interest rates and vice versa.

Q. What’s the difference between fixed and floating-rate loans to the repo rate?

The former follows changes in the repo rate, and the latter has nothing to do with it.

Q. How can I benefit from repo rate changes?

Loan refinancing happens when you reduce EMIs with a lower repo rate.

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