Why Your EMI Dont Change

SHILPA had taken a home loan in December 2007. With an 11 per cent floating interest rate, she pays an EMI of Rs 9,100 and has Rs 8 lakh outstanding. Shilpa's bank declared a 50 basis point reduction in rates in the first week of April. However, when she checked out the details of her latest loan repayment at the start of May, she found that she was still paying the old higher rate (or the old equated monthly installment). Shilpa now wants to know why the benefit has not yet been passed on to her.'

How it works
There are two things that matter when a bank cuts or increases its interest rate.
1. The actual percentage hike or cut
2. The 'reset' clause

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What is 'reset' clause
In case of new loans, any change in the interest rate is impacted immediately or within a few days. But in case of existing loans, some time passes before any benefit is passed on

This reset clause is mentioned in your loan agreement. It is the actual time period from which the rate will be implemented. The reset period can be monthly, quarterly, half-yearly or even yearly.

So, if a loan was taken in November and there is a quarterly reset then the reset dates will be in November, February, May and August. This can differ depending upon the loan conditions.

Why such a clause

This reset time period is used by the bank for ease of calculation and certainty in the process. There are crores of loans that are outstanding and if the rates are reset on any random day then calculating interest can become a very tough task for both the borrower and the lender. The specific time period ensures that the reset of the rate will take place at given time intervals.

Implication for the borrower
What this means is that if there is any rate change in the interim period (between two reset dates) then this would take effect only when the next reset time period arrives.

In the above example, Shilpa has a quarterly reset clause, so the next rate change will take place for her in the month of June. This is why Shilpa's situation has not changed in the month of April.

And there's more bad news. The benefit will accrue to her on the principal outstanding from June and not April. So, if the outstanding is Rs 8 lakh in April and Rs 7.75 lakh in June, the new interest rate will apply on Rs 7.75 lakh.

Shilpa has a loan outstanding of around Rs 8 lakh with an interest rate of 11 per cent where the EMI is Rs 9,100 and the remaining loan period is 180 months or 15 years. Her bank has lowered the rate by 50 basis points, which will translate into her repayment period being reduced by around 12 months. This will ensure that Shilpa pays a lower number of EMIs when the amount remains the same.

Is there anything a borrower can do?

Presently, there is little that you can do. Borrowers cannot negotiate in most cases because this is a standard part of the loan agreement and banks do not negotiate on this as their specific products have a specific reset clause . The general reset clause for most banks is also quarterly because it's convenient for them to implement it. So, the only thing you could do is negotiate for a quarterly reset clause if your agreement is asking for more.