Lenders across the country borrow funds from the Reserve Bank of India for lending purposes. Now, lenders can borrow money without pledging any security or by pledging government securities, such as cash and gold. When commercial lenders borrow money by pledging government securities, the Reserve Bank of India charges interest in the form of the Repo Rate. Repo is the short form for Repurchase Agreement. When a lender borrows money from the Reserve Bank of India by paying interest at the Repo Rate and dipping into their liquidity profile, the lender essentially enters into an agreement with the Reserve Bank of India that it will repurchase the pledged securities before a pre-decided due date. 

The Reserve Bank of India can change the Repo Rate every three months. The current repo rate for home loan is 6.50% per annum. 

The Repo Rate is an important monetary policy tool and the Reserve Bank of India uses this tool to curb inflation and maintain economic growth. Let us try and understand how does the Reserve Bank of India use Repo Rate to the benefit of the country.

When inflation within an economy increases continuously, the prices of commodities as well as goods and services go up, making these unaffordable to the common people. It is, thus, that every time inflation goes beyond a certain level, the RBI steps in to bring it back under control. The RBI controls inflation by increasing the Repo Rate. When the Repo Rate goes up, lenders have to borrow money from the Reserve Bank of India at a higher rate of interest. In other words, when the Repo Rate goes up, borrowing money becomes expensive and therefore, lenders charge a higher interest rate from borrowers as well. This reduces the flow of money within the economy as people borrow less and therefore, have less to spend, which in turn, helps bring down the prices of commodities and good and services and in turn, inflation under control. 

When the Repo Rate goes up, all loans including home loans become expensive. Borrowers have to pay a higher home loan interest rate if they borrow at a time when the Repo Rate is already high. In the case of Repo Rate-linked home loans, borrowers’ home loan EMIs go up too. Thus, borrowers are advised to never borrow money at fixed interest rates when the Repo Rate is high. At such times, they must always avail themselves of a home loan at floating interest rates so that they can benefit from rate cuts at a later stage.

On the other hand, when economic growth within the country slows down, the RBI decreases the Repo Rate. This, in turn, makes borrowing money cheaper. Thus, when the Repo Rate goes down, people borrow more and spend more. In very simple words, the Reserve Bank of India decreases the Repo Rate when it wants to increase the flow of money within the economy. When the RBI decreases the Repo Rate, all loans, including home loans become more affordable. Further, RBI rate cuts lead to lower, more affordable EMIs for home loan borrowers on floating interest rates. Borrowers planning to buy a home and avail themselves of a home loan must apply for one when the Repo Rate is low and therefore, home loans are cheaper. 

Read More:- Complete Guide To The Home Loan Process