Prime Lending Rate (PLR) in Home Loan: A Guide

Understanding the prime lending rate (PLR) is crucial for home loan borrowers in India. PLR serves as a benchmark for determining home loan interest rates on various loans, including home loans. Let's understand PLR and its impact on home loan borrowers.

What is the Prime Lending Rate (PLR)?

The prime lending rate (PLR) is a benchmark interest rate set by commercial banks in India. It represents the rate at which the bank is willing to lend to its most creditworthy customers.

The PLR has been a significant factor in India's banking system for decades. It has served as a reference point for home loan interest rates on various loans, including home loans.

PLR rate plays a crucial role in the home loan market. It directly influences the interest rates that banks charge to borrowers. Understanding PLR in home loans can help you make informed decisions when applying for a home loan.

How does PLR work in Home Loans?

The PLR acts as a base home loan interest rate. Banks add a margin based on the borrower’s risk profile, loan amount, and tenure. A high-risk borrower may have a significant markup added to the PLR, while a low-risk borrower may see a minimal increase over the base rate. This differential pricing allows banks to manage their lending risk while keeping loans accessible to a broad range of customers.

Banks use the PLR to calculate home loan interest rates by adding a percentage margin. For instance, if a bank’s PLR rate is set at 10%, and the borrower has a good credit score, the bank might offer a loan at PLR plus 1.5%, bringing the interest rate to 11.5%. However, if the borrower has a weaker financial profile, the bank may add a higher margin, say 3%, making the effective interest rate 13%.

The difference between PLR and MCLR

The introduction of the marginal cost of funds-based lending rate (MCLR) in 2016 was a major reform to bring greater transparency and fairness to lending rates. While PLR is determined solely by the bank and can be opaque, MCLR is calculated based on a formula that takes into account factors such as the marginal cost of funds, operating costs, and the cash reserve ratio.

The MCLR is more dynamic, adjusting periodically based on market conditions. Unlike PLR in home loans, which can remain stagnant for long periods, MCLR adjusts more frequently to reflect changes in economic conditions, making it more beneficial for borrowers. However, loans sanctioned before MCLR’s introduction may still be linked to PLR, which is why understanding the nuances of both is important.

Factors affecting Prime Lending Rate

Several macroeconomic factors impact the prime loan rate.

• Inflation: It is one of the key drivers, as higher inflation often leads to higher interest rates. When inflation rises, the Reserve Bank of India (RBI) may hike the repo rate, which is the rate at which banks borrow money from the RBI. In turn, banks raise their PLR to maintain profitability.
• Government policies: Factors such as fiscal stimulus or restrictions on lending can also cause fluctuations in the PLR. During periods of economic slowdown, the government may introduce measures to lower interest rates to stimulate borrowing, whereas, during periods of high economic growth, PLR may rise as banks become more cautious with their lending practices.
• Role of the RBI: Though it does not directly control the PLR, the RBI influences the lending rates by adjusting the repo rate and other monetary policies. When the RBI lowers the repo rate, it becomes cheaper for banks to borrow money, which often leads to a reduction in the PLR. Conversely, a hike in the repo rate leads to an increase in the PLR as borrowing costs rise for banks.

  

• Individual Bank Policies: Each bank sets its own PLR based on its internal policies, cost structures, and risk appetite. Some banks may have a more aggressive lending strategy and offer lower PLRs to attract customers, while others may maintain higher PLRs to protect themselves from potential risks.

Impact of PLR on Home Loan borrowers

Borrowers often have the option to choose between fixed and floating interest rates on their home loans. Fixed rates remain constant throughout the tenure, providing stability but often at a higher rate. On the other hand, floating rates are linked to the PLR rate or MCLR and fluctuate with changes in these benchmarks. While floating rates may offer lower initial interest rates, they carry the risk of future rate hikes, which can increase the borrower’s EMIs over time.

Wrapping Up

The prime lending rate is an important component in determining home loan interest rates, impacting how much borrowers pay each month. Whether you're a new borrower or managing an existing loan, understanding the role of PLR can help you navigate the loan process more effectively. For tailored solutions and expert guidance, explore the offerings at IIFL Home Loans.