Choosing the frequency of an MCLR reset for your loan

When interest rates fall, it is beneficial for borrowers to have a shorter reset period as rate cuts will be passed on quickly to your EMI.

Q. I have a loan account in one of the government banks and my interest is based on MCLR with a lock-in period of one year. My loan interest was reset in April and the rate of 8.5% will continue for a year. I feel I may be missing out on reduced interest rates due to this one-year reset. I am not able to conclude if it is a good idea to change the tenure of MCLR to 6 months or 3 months, or continue with the prevailing one year. Any guidance on this will help me greatly in concluding and finalising the MCLR frequency.

Nitin Kumar

A. With the Monetary Policy Committee reducing rates, interest rates on loans have been falling quite sharply in the last couple of years. Therefore, yes, having a one-year reset on your MCLR loan has led to delay in these rate cuts being passed on to you. However, whether a shorter reset will benefit you depends on the direction of interest rates from here.

When interest rates fall, it is beneficial for borrowers to have a shorter reset period as rate cuts will be passed on quickly to your EMI. But if rates are going to rise, then a longer reset will be to your advantage as rate increases will only slowly show up in your EMI.

Today, after falling steadily for the last five years, we believe that the fall in India’s interest rates may have bottomed out. The RBI’s repo rate, the benchmark rate for the economy, is already at its lowest level in over two decades.

While it bottomed out at 4.75% in the previous cycle during the global financial crisis, now it is already at 4%. With high inflation rates and an economy that is returning to growth after a COVID-induced recession, the MPC has also been in pause mode after last cutting the repo rate in May 2020. It therefore looks as if market interest rates will either stay sideways or rise over the next few months to one year.

If the economy normalises quickly, market interest rates may also increase sooner, from the unusually low COVID-induced levels. Given this possibility, this is the wrong time to move to shorter resets on your floating rate home loan.

A longer reset will be more useful as it will delay the impact of rate increases on your EMI outgo. However, if your home loan rate is 8.5% currently, you do seem to be paying higher rates compared to rates available for the best borrowers in the market, which are at less than 7%. Do check out if moving to a repo-linked home loan at the same bank (this loan is directly linked to RBI’s repo rate) will work out cheaper.

You can also examine if transferring your loan balance to another bank or housing finance company can reduce your EMI by giving you a more competitive rate.

Even after such a switch though, you will be at risk of a rise in rates. Therefore, do opt for longer resets after a switch.

Q. I just started working a year ago. I wanted to start saving for my future. I really don’t have any idea about where to invest. I got to know about RBI issuing sovereign gold bonds and bought 16 gm valued at ₹74,832. Was that a good move? Gold prices have been increasing during the lock-down. Was this a good time to buy these bonds?

Arun JP

A. While Sovereign Gold Bonds (SGBs) are a good vehicle through which you can add gold to your portfolio, investing all your savings in one asset is not a prudent course of action as poor performance or lack of liquidity in that asset can materially affect your financial position. In future, it would be best for you to save and invest your earnings in line with a well-thought out financial plan.

While it is good that you are thinking about saving so early in your career, investing requires a bit of planning first. Your first move while embarking on your investment journey should be to create an emergency fund amounting to about six months’ basic expenses.

This sum should be parked in fixed deposits from leading banks for you to draw upon any time you have a need.

Do get a medical insurance plan too, if your employer doesn’t offer one. Before deciding where to invest the rest of your money, it would be advisable to map out financial goals towards which you would like to save or invest.

Do list out, with the help of your family if need be, the key life goals you have in mind over the short term (within three years), medium term (3-7 years) and long term (seven years plus). Mapping out your goals in this fashion will then help you decide how much you should save and how you can allocate your savings among assets such as gold, fixed deposits, debt and equities.

Usually for goals that are less than three years away, bank fixed deposits are your best bet. For 3-7 years you can consider post office schemes such as NSC, debt mutual funds, company FDs and gold. For goals that lie seven years or more from now, you can consider allocating among equity funds (index or multicap funds), debt funds, public provident fund and SGBs — as they have an 8-year maturity.

Despite the recent surge in prices, gold is not an asset that can generate double-digit returns for your portfolio in the long run.

It is an asset that performs the role of insurance by protecting your portfolio value from drastic swings in other assets. Gold tends to perform well when other assets such as equities or debt don’t deliver.

We suggest investing 5-10% of your overall savings in gold in a systematic manner either through SGBs or gold exchange-traded funds.

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