Chasing lower EMIs? MCLR or RLLR — Which loan regime best captures RBI’s rate cut

As the Reserve Bank of India (RBI) slashed interest rates earlier this year—including a significant 50-basis point cut in June—borrowers have welcomed the relief of potentially lower EMIs. Yet, behind the cheer of cheaper loans lies a crucial financial decision: choosing between different types of interest rate benchmarks that lenders use to price loans.

Banks and NBFCs in India typically offer floating-rate loans linked either to internal benchmarks like the Marginal Cost of Funds-based Lending Rate (MCLR) or external benchmarks, predominantly the Repo-Linked Lending Rate (RLLR). Each comes with unique mechanisms for how rates are set, adjusted, and passed on to customers.

How MCLR works

Introduced in 2016, the MCLR replaced the older base rate system. It’s calculated by banks based on factors like their marginal cost of funds, operational costs, tenor premiums (higher rates for longer loans due to increased risk), and regulatory costs such as the negative carry of maintaining the cash reserve ratio (CRR) with the RBI without earning interest.

Large banks with lower operational costs and cheaper access to funds tend to offer lower MCLR rates than smaller institutions. However, changes to MCLR rates typically lag behind RBI’s rate adjustments. For example, despite the RBI cutting the repo rate by 100 basis points this year, SBI has kept its one-year MCLR steady at 9% since November 2024. Historically, during periods of rising rates, MCLR loans have also shown a slower pace of increase, giving borrowers time to adjust financially.

Akhil Rathi, Head – Finance Advisory at 1 Finance, elaborates on this delay. “After an RBI rate cut, the key concern for any home loan borrower is, will my EMI or tenure reduce, and how soon? If your loan is linked to MCLR, the benefit doesn’t reflect immediately. Even if the repo rate is reduced today, your interest rate may only adjust after 6 or 12 months, depending on the reset period. This delay can result in higher interest payments during the waiting period.”

Repo-Linked Loans

In 2019, the RBI mandated external benchmarking for lending rates, leading to the widespread adoption of RLLR. These loans directly track the repo rate—the rate at which the RBI lends to commercial banks—meaning rate changes are passed on to borrowers, typically within three months.

“Now consider RLLR, which is directly linked to the RBI’s repo rate,” says Rathi. “If the central bank cuts the repo rate by 0.50%, your loan interest rate is likely to reduce within a month or two. RLLR ensures quicker transmission of policy rate changes and brings more transparency, as it follows an external benchmark. In contrast, MCLR is based on the bank’s internal cost structure and reacts slower, especially when rates are falling.”

However, borrowers should note that loans aren’t offered at the pure repo rate. Lenders add a credit risk premium, usually between 2.5% and 3.5%, depending on the borrower’s profile and the institution’s assessment of risk.

While RLLR loans can quickly lower EMIs during rate cuts, they also expose borrowers to rapid EMI hikes when rates rise, potentially straining household budgets.

Choosing between MCLR and RLLR

Both systems have merits. Borrowers with manageable EMIs and a high capacity to absorb sudden interest rate swings might prefer the faster transmission of RLLR loans. Conversely, those seeking stability and predictability may find MCLR-based loans more suitable, especially in volatile rate environments.

“Considering the faster rate transmission, quicker EMI or tenure benefits, and greater transparency, RLLR is clearly the more borrower-friendly option in today’s interest rate environment,” concludes Rathi.

Borrowers can switch between regimes for a fee, making it worthwhile to assess individual circumstances and market trends before deciding.