What Is Repo Rate? How Does It Affect The Interest Rates Of Loans In 2022?

Wondering what is repo rate? Read on.

On May 4, the Reserve Bank of India (RBI) Governor announced a surprise hike in repo rates. For the past two years, the repo rate has remained at a steady 4%. After the RBI’s decision, the current repo rate stands at 4.4%. 

This unexpected announcement generated buzz because any change in the RBI repo rate indicates an inevitable change in borrowing rates and deposit rates as well. Moreover, according to the RBI guidelines, any change in repo rates has to be passed on to the consumers as early as possible. So, the sudden hike has caused distress for those planning to get a loan because lenders and other financial institutions will soon start increasing the interest rates, and there is no buffer time.  

So, what is the meaning of repo rate? How does it impact the interest rates on loans? And, if lenders are going to hike their interest rates, what can borrowers do? Keep reading to find out. 

What do you mean by repo rate?

What is repo rate?

When you need funds, you can approach a lender financial institution for a loan that you agree to repay at a given rate of interest. Similarly, when lenders and financial institutions face a lack of funds, they can borrow funds from the Reserve Bank of India at a fixed rate of interest. This rate of interest charged to the financial institutions is the current repo rate of the RBI. 

Where does the term repo come from?  

Repo stands for ‘repurchasing option.’ When financial institutions approach the RBI for a loan, they sell eligible securities to the RBI with an agreement to repurchase them at a predetermined price. Thus, the financial institution gets the funds while the RBI holds the security. 

Now that you have an answer to ‘what is repo rate?’, let us understand the importance of the repo rate, meaning how it affects the economy and the individual.  

What is the significance of the RBI repo rate?

The current repo rate can regulate the country’s money supply, liquidity, and inflation. Let us look at some scenarios where it acts as an effective means of monetary control: 

• Managing inflation: When inflation levels rise, the RBI attempts to limit the flow of money in the economy. Here, one method to do this is by increasing the RBI repo rate. A high rate makes borrowing costlier for businesses and industries, leading to an economic ‘squeeze.’ This slows down investment and the supply of money in the market and restricts the growth of the economy. 

This, in turn, helps in controlling inflation and preventing economic squeezes. Conversely, when the RBI needs to increase funds into the system, it lowers the rate. Businesses and industries find it easier to access loans and borrow funds for investment. It also increases the overall flow of money in the economy, boosting the economic growth rate. 

Hedging and leveraging: The Reserve Bank of India purchases securities and bonds from lenders and financial institutions with the aim of hedging and leveraging. It then provides them with short-term funds in return for the collateral deposited.  

• Maintaining liquidity: The RBI lends money for a very short period of time, the maximum being an overnight duration. After this, financial institutions have to repurchase their securities deposited at a predetermined price. 

Financial institutions borrow money from the RBI to maintain liquidity or cash reserve as a precautionary measure. Thus, when the RBI needs to increase the flow of money, it reduces the repo rates, meaning it encourages financial institutions to borrow. 

Current repo rate of RBI and past repo rate trends

What is repo rate’s trajectory over the years? The latest repo rate is 4.40%. The trend over the previous few years is:

How does the repo rate affect the interest rate on loans?

Any change in the repo rate, meaning decrease or increase, will immediately impact all loans, whether they are housing loans, car loans, or personal loans. With the current hike, floating-rate loans will get costlier. All new loans, whether fixed or floating, are likely to be priced higher. 

Thus, for borrowers, this will lead to higher interest outgo and heftier EMIs. So, if you are in the process of repaying a loan or are planning to avail of one, the increased current repo rate will affect your repayment.

If you have taken a personal loan or a car loan with a fixed rate of interest, you will not see any change in your EMI. But, if you have taken a loan with a floating rate of interest, such as a housing loan, your future EMI values will become higher. 

What can a borrower do?

Now that you know what is the meaning of repo rate is and how it affects you, you can take the following measures: 

• If you want to take a loan, apply as soon as possible because the rates of interest on loans are going to keep increasing. 

• If you are repaying any loan that has less than 5 years of tenure remaining, opt for an increase in EMI. You can request your lender to revise your loan terms if needed or switch from a floating rate to a fixed one. 

• But, if your ongoing loan has more time remaining, say 10 years or more, you can consider a loan balance transfer. Research and compare the latest loan interest rates among lenders, and switch to one that is more affordable. You can use a loan EMI calculator to estimate your EMI values in both cases. Remember to calculate the cost of the new loan and consider additional fees like foreclosure charges, processing fees etc., before you make a decision! 

In conclusion 

With the sudden increase in repo rates and the ongoing trends in retail inflation, experts predict that the cost of loans will become higher. Besides, now you have an understanding of repo rate meaning, its impact on loans, and what you should do. So, if you are planning to take a loan, do it at the earliest. 

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