Understanding the Impact of Repo Rate on Your Finances

Understanding the Impact of Repo Rate on Your Finances

Repo rate is one of the most important instruments of monetary policy. The Reserve Bank of India (RBI) determines the repo rate at which it lends money to the commercial banks. In turn, the commercial banks use this funding for their short-term cash flow requirements. Changes in the repo rate impact the cost of borrowings in the economy, which in turn affects various financial products such as home loans, personal loans, car loans, and credit card debts.

Understanding the mechanics of repo rate will help you to comprehend the various ways it impacts your finances.

What is Repo Rate?

Repo rate is the short form of repurchase rate, which is the interest that the RBI charges on the funds lent to the commercial banks. The commercial banks have to present government securities as collateral on the loan. When the repo rate increases, banks find it expensive to borrow money from the RBI, which in turn causes them to hike lending rates. If the repo rate decreases, banks can borrow money from the RBI at a lower rate, which makes lending cheaper.

The RBI uses changes in Repo rate to balance inflation and boost economic growth. When the RBI wants to reduce inflationary pressure in the economy, it increases repo rate, which reduces the availability of credit and controls prices. On the other hand, when the economy needs a stimulus to achieve growth, the RBI reduces the repo rate, which increases credit availability and pumps more money into the economy.

Impact on Home Loans

Home loans are one of the most significant retail lending products, and even a slight change in the repo rate has a visible impact on them. In most cases, the housing loan EMI accounts for a substantial percentage of monthly expenses for a salaried employee. When the RBI reduces the repo rate, banks reduce the interest rates on home loans, which makes housing more affordable. A drop of 1% in the home loan rate can lead to a saving of up to Rs. 2,400 a month on a 30-year loan of Rs. 30 lakhs. If the repo rate increases, housing loan interest rates also go up, which leads to higher EMIs, and paying more for the same property.

Impact on Personal Loans

Personal loans are unsecured loans, and the interest rate on them is relatively higher than Home loans. When the RBI increases the repo rate, banks will also raise the interest rate on personal loans, making the borrowings dearer, and it leads to a significant impact on monthly expenses. It is always better to opt for a personal loan when the repo rate is low, which will lower the monthly EMI burden.

Impact on Car Loans

Car loans are also affected by changes in the repo rate. When the repo rate goes up, car loan rates also increase, making it more expensive to buy a car on credit. If the repo rate decreases, it will result in cheaper car loans, which means lower EMIs for borrowers.

Impact on Credit Card Debts

Credit card debts are the most expensive form of borrowings as they come with a high rate of interest, and many people carry their balance forward. When the repo rate increases, banks increase credit card interest rates, making it challenging to repay the outstanding balance. If you have a high balance on your credit card, it is always better to move the balance to a personal loan when the interest rates are low.

Impact on Fixed Deposits

Fixed deposits are among the most popular investment options for risk-averse investors. When the RBI reduces repo rate, banks also lower the rate on fixed deposits, which reduces the earning potential of the investment. When the repo rate goes up, banks increase the interest rate on fixed deposits, which makes it an attractive investment option for investors looking for stable returns.

Impact on Savings Deposits

Banks offer attractive interest rates on savings deposits to attract customers. When the repo rate increases, it becomes expensive for banks to borrow money from the RBI. In response, they cut interest rates on savings deposits to remain profitable. Conversely, when the repo rate comes down, banks offer higher interest rates to woo customers towards saving accounts. Hence, when the repo rate decreases, it is better to put money in savings accounts as the interest rate will be higher.

Impact on Credit Scores

Credit score is a crucial parameter for availing any loans, and changes in repo rate can also affect it indirectly. When the RBI increases the repo rate, it leads to an interest rate hike on borrowings, making it challenging for people to repay loans on time. It can lead to late payments, missed deadlines, and ultimately, lower credit scores. On the other hand, when the interest rates decrease, people can repay their loans on time, leading to an improvement in credit score.

Impact of SLR Changes on Repo Rate

SLR (Statutory Liquidity Ratio) is the percentage of deposits that banks must maintain in the form of liquid assets like government securities, gold, and cash. SLR plays a critical role in controlling liquidity, and it is often used by the RBI to influence repo rate.

When the RBI wants to increase the repo rate, it increases the SLR, which forces banks to maintain higher levels of liquid assets. It leaves less money available for lending, which increases the cost of borrowing. Conversely, when the RBI wants to reduce the repo rate, it reduces the SLR, which makes more funds available for lending, leading to a drop in lending rates.

Final Words

Repo rate plays a significant role in the economy, which affects various monetary instruments and, consequently, your finances. Understanding the impact of repo rate helps you to make informed financial decisions, mitigating the impact of changes in repo rate on your finances. Hence, always keep an eye on the developments in the market and act accordingly to get the maximum benefit of the repo rate regime.

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