Personal loans: Impact of rate cuts on different types of loans – An explainer

Early this year, the Reserve Bank of India (RBI) is expected to cut down benchmark interest rates (or repo rate). This is also known as repurchase rate i.e., the rate at which the RBI lends money to commercial banks in exchange for government securities. The current repo rate is 6.5 percent. The start of rate cut cycle which is expected to commence early this year will lead to reduction in the deposit as well as lending rates.

This means when repo rates are cut, depositors will earn lower rates on their deposits and borrowers will be able to withdraw money at lower interest rates.

The lower the repo rate, the lower are the rates at which banks can further lend to borrowers. On the other hand, the higher the repo rate, the higher the lending & borrowing rates.

Personal loan

Banks generally charge interest from borrowers based on marginal cost of funds-based lending rate (or MCLR) which constitutes components such as deposit rates, repo rates, operating costs and cash reserve ratio (CRR). So, when RBI raises repo rate and the CRR, the banks are made to incur an extra cost to be able to raise funds, thus raising cost of lending. 

This leads to higher interest rates charged by banks.

Typically, a small increase in repo rate may even lead to a higher increase in interest rate. So, banks sometimes pass on a higher burden on the borrower.

Home loan

A report by Jefferies suggests that RBI may cut policy rates by 50 basis points (bps) in the first half of 2025. And if that happens, the interest rate charged by banks on home loans – at floating rates -- would likely fall. The actual impact would vary from bank to bank and may, or may not, correspond to the cut in repo rate.

Car loan

A car loan can be given on fixed or floating rate based on the borrower's choice. Although there is no change in the fixed interest rate during the loan’s tenure, the floating rate can move upward or downward depending on the change in repo rate. So, if the repo rate is cut down this year (2025), the interest rate on car loans would fall too.