“Banks may reduce the other spread components for the benefit of the borrower earlier than three years,” RBI said in its latest directions on interest rate advances. This means that if RBI lowers its benchmark lending rates or if your credit score improves, you will get the full benefit in the form of a reduction in EMIs sooner in the coming months than is the case now.
In effect, thanks to the RBI’s latest directions, banks can reduce the non-credit-risk part of the spread whenever they lower lending rates. As a result, borrowers need not wait for several months to get the full benefit of interest rate cuts or improvement in credit scores. Borrowers with floating interest rate loans will be the direct beneficiaries of the RBI move.
Faster transmission of rate cuts
Banks and financial institutions calculate their lending rates by taking into account the prevailing repo rate (the rate at which RBI lends to the banks) and the spread. The spread in a loan is based on your credit score, the tenure of the loan, and the bank’s profit margin. It is the additional percentage banks charge to cover their operational costs and also includes their profit margins. The spread varies with each lender and is ruling at 2.5%-3% for home loans. So, the interest rate will work out to 8%-8.5% per year (the current repo rate of 5.5% plus the spread) for home loans based on repo rates.
Despite a spate of rate cuts in recent months, the transmission of lower interest rates to borrowers has been quite slow in the system. The RBI has cut rates three times during 2025, reducing it by 100 bps (1%), bringing the repo rate to 5.5%, its lowest level since August 2022. While interest rates adjust typically every three months for repo-based loans, it takes 6-12 months for the transmission to happen in MCLR (Marginal Cost of Funds-based Lending Rate) loans.
This happens since MCLR is based not just on the repo rate but also on the liquidity in the banking system and the cost of funds incurred by banks. As a result, the transmission of interest rate changes is slower in MCLR.
Borrowers advised to be proactive
But to get the full benefit of the recent RBI move, you have to be proactive. You should check the interest rate at which you borrowed money (for floating interest rate borrowers) and the current rate. If there is a drop, you should call the bank and demand a reduction. The same applies to credit scores. If your credit score has improved after you have taken the loan, you can call the bank and request a reduction in interest rates based on your enhanced creditworthiness.
The RBI has also continued an option that it had introduced—allowing floating rate borrowers to switch to fixed rates. “Banks may, at their discretion, provide the option to switch over to a fixed rate at the time of reset at their discretion,” RBI said. Banks should also specify the number of times a borrower will be allowed to switch during the tenor of the loan, it said.
Allirajan M is a journalist with over two decades of experience. He has worked with several leading media organisations in the country and has been writing on mutual funds for nearly 16 years.
