When people borrow money from banks, they have to pay an interest rate. The same is true for financial institutions that borrow money from the central bank. This rate is called the "repo rate." Repo is short for "repurchase agreement" or "repurchasing option." Under the deal, scheduled commercial banks give the RBI securities like treasury bills or gold so that they can get overnight credit if they need it. It's important to note that banks need money in order to lend it out. They can also borrow from the central banks if they don't want to take deposits from the public. This is possible because of agreements to buy and sell.

Aside from making credit available to banks, the repo rate is a good way for the banking regulator to keep inflation in check. When inflation is high, the RBI raises the repo rate to make banks less likely to borrow money. This eventually makes the economy less liquid, which brings down the high inflation. In case inflation goes down, a different plan is put in place. In this case, the repo rate is lowered to get banks to borrow more money. This increases the amount of money on the market, which leads to new investment activity. Note that the RBI only gives the banks credit for one day, and the banks can only buy back the securities they deposited with the banking regulator at a set price.

When the Reserve Bank of India (RBI) modifies the repo rate, homebuyers are informed that the cost of borrowing will increase/decrease. As the repo rate has such a substantial impact on your finances, it is essential to understand every aspect of it and how it affects the liability of your home loan. In order to have a clearer understanding of how your home loans operate, it is also vital to understand how the reverse repo rate works.

On August 5, 2022, the Reserve Bank of India (RBI) hiked the repo rate by 50 basis points, bringing it to 5.40%. This is the third consecutive increase in the repo rate this fiscal year, following increases of 40 basis points in May and 50 basis points in June. In this fiscal year, the RBI has raised the repo rate by 140 basis points.

How are house loans affected by changes in the repo rate?

When the Reserve Bank of India reduces the repo rate, the cost of borrowing for banks decreases. Banks are likely to eventually pass on this benefit to customers. In the past year, the banking institution has reduced the repo rate by 200 basis points, bringing it down to 4% in response to a decline in consumer demand caused by the Coronavirus outbreak and its negative economic impact. In order to encourage consumers, banks have recently begun reducing home loan interest rates. State Bank of India, the country's largest bank, recently slashed its repo rate-linked home loan interest to a historic low of 6.95%.

In contrast, house loan interest rates increase when the RBI increases its lending rate. In addition, banks are quicker to pass on rate increases to clients, but they are typically fairly slow to reduce lending rates. Even while changes in the repo rate should be reflected promptly in the interest rates of financial institutions, only rises are transmitted quickly, and the RBI frequently has to encourage banks to pass on the benefits of reduced rates to borrowers.

With banks connecting their home loan interest rates to the repo rate as of October 2019, future policy transmission may be accelerated. Prior to this, banks priced house loans using internal lending benchmarks such as marginal cost-based lending rate (MCLR), base rate, and prime lending rate.

What should prospective home buyers note?

People who want to buy a home with a loan based on the repo rates or switch their current home loans to these rates need to know a few things about these loans. Changes in the repo rate are more likely to show up in your EMI payment much more quickly. With home loans that are linked to the repo rate, loan rates will change much more quickly. Also, the rate-setting system for these loans will be clearer, which should make it easier for borrowers to predict the interest rates on their loans. This also means that if the bank regulator changes the key lending rate, your home loan payment will go up. So, when interest rates are going up, loans that are tied to the repo rate can affect buyers.