How Repo Rate Affects Your Personal Loan: What Should You Know?

When the repo rate rises, banks must pay more for borrowing funds and pass on the higher cost of borrowing to customers in the form of higher interest rates

A high repo rate affects personal loan affordability and overall financial health.

Source : ABPLIVE AI

The repo rate has remained steady for many months due to high inflation. The Reserve Bank of India (RBI) paused rate hikes after its monetary policy review in April 2023, and since then the repo rate has remained at 6.5 per cent. The high repo rate has impacted borrowing costs, including personal loans, which are often linked to the repo rate. So, what does this mean for borrowers? or borrowers? 

What is the repo rate & how does it affect you?

Repo rate refers to the rate at which the RBI lends money to banks. When the repo rate rises, banks must pay more for borrowing funds and pass on the higher cost of borrowing to customers in the form of higher interest rates. Conversely, when the repo rate drops, borrowing becomes cheaper for banks, as do loans.  

Personal loans are often linked to a bank's Marginal Cost of Funds-based Lending Rate (MCLR) or Repo Rate Linked Lending Rate (RLLR). Any movement — or lack of movement — in the repo rate directly affects these lending rates. For example, if the repo rate remains steady at 6.5 per cent, personal loan interest rates may hover around 13 per cent-15 per cent. Borrowers must manage high EMIs which can make loans costlier over time. This can be especially challenging for borrowers already managing with tight budgets. 

How high repo rates impact borrowers

An extended period of high repo rates can strain a borrower’s finances. High repo rates lead to costlier loans, which then lead to higher interest rates and EMIs, straining your budget. 

Some borrowers opt to restructure their loans by extending the tenure to lower their EMIs. While this provides immediate relief, it increases the total interest outgo due to the extended tenure, making the loan more expensive in the long run. 

For new borrowers, high repo rates mean costlier loans. In the case of personal loans, which are often taken for short-term needs or emergencies, the elevated rates may lead borrowers to reconsider borrowing altogether.

What should borrowers do?

1. Consider prepayment: If you have surplus funds, use them to prepay a part of your loan. This will lower your principal amount, and thus, your interest. For instance, if you have a Rs 5 lakh loan at 13 per cent interest for five years, prepaying Rs 1 lakh in the second year can save you over Rs 30,000 in interest.

2. Refinance or balance transfer: If current rates are untenable, look for other lenders offering lower rates. When deciding, consider the fees involved to refinance and weigh it against the potential savings. If savings are higher, then refinancing may be a wise choice.  

3. Prioritise debt: Focus on clearing high-interest loans first. If you have multiple loans, consolidating them into one at a lower rate can also help reduce debt.

4. Borrow wisely: Avoid taking new loans unless necessary. Discretionary borrowing during periods of high rates can worsen your financial situation.

A high repo rate affects personal loan affordability and overall financial health. As a borrower, you must be proactive — prepay when possible, refinance for better terms, and avoid unnecessary loans. Assess your options carefully and make decisions that align with your financial goals. In times like these, a little planning goes a long way. 

The author is the DGM, Communication at BankBazaar.com. This article has been published as part of a special arrangement with BankBazaar.