When lenders lend money to borrowers, they charge interest. Similarly, when the Reserve Bank of India lends money to lenders, the central government of the country also charges interest. This interest is known as the Repo Rate. Repo is the abbreviated form of Repurchasing Option.

While we are on the topic of repo rate, let us clarify the meaning of Reverse Repo Rate. Reverse Repo Rate is the interest rate that the Reserve Bank of India pays lenders when it borrows money from them. Yet again, the RBI uses the concept of the Repo Rate to control inflationary pressures within the economy.

Banks and lenders take money from the Reserve Bank of India to ensure they have ample credit to give to borrowers at all times. Though the concept of the Repo Rate helps banks remain liquid at all times, the RBI uses the concept as a way to control inflation within the economy as well as push economic growth.

If you have applied for a home loan in India, you must understand what is repo rate and how it affects home loan interest rates for those who are on a floating rate regime.

Lenders lend money to borrowers to buy a home and charge interest on it under two different interest regimes: fixed and floating rates. Under the fixed interest rate regime, lenders charge interest on a fixed rate. Thus, in this case, the home loan interest rates do not vary based on the market conditions. However, this is not the case for floating interest rates. Floating interest rates vary based on market conditions. Let us explain this further.

When inflation within the economy increases and the prices of things become higher, the Reserve Bank of India reduces the flow of money or cash within the economy by increasing the Repo Rate. When the Reserve Bank of India increases the repo rate, banks and lenders have to pay a higher rate of interest to the RBI. To make up for this, lenders charge a higher rate of interest on loans. Thus, when the RBI increases the Repo Rate, loans become expensive. On the other hand, when the RBI reduces the Repo Rate, loans become cheaper.

Until 2016, lenders linked their rate of interest to the MCLR or Marginal Cost of Funds-Based Lending Rate. While this was a nice concept, the problem with it was that whenever the RBI increased its interest rates, lenders used to pass rate hikes to borrowers immediately. However, when the RBI reduced the interest rates, lenders would be slow to pass on the benefits to the borrowers. To increase transparency in how lenders charge interest on loans, the RBI introduced the concept of the Repo Rate.  

If you are planning to apply for a home loan in India, make it a point to opt for a repo-rate linked home loan. This way, whenever the interest rate on home loans would go down, loans will become cheaper for you. However, when the interest rates go up, you will also be required to pay higher EMIs.

Those planning to avail of a home loan in India must also remember to use a home loan calculator to figure out the loan amount they can borrow and easily repay. The home loan EMI calculator is a very handy tool that helps with loan planning. So, remember to use it.