What is a base rate?

July 1, 2010, was a significant date for banks and borrowers. That was the day when the new regime for benchmarking home loans – the base rate system – came into being. Now, interest rates on all loans extended post July 1 are linked to the new system.

The new system was introduced by the Reserve Bank of India (RBI) in response to complaints from home loan borrowers of the partisan approach adopted by banks while raising home loan rates. Banks were accused of making attempts to entice new borrowers with lower rates even as the benefits of a benign interest regime were sparingly passed on to existing borrowers. And in a hardening rate scenario, banks rarely hesitated to increase rates for old borrowers . The base rate system was put in place with the objective of enhancing transparency in loan pricing and ensuring fair treatment to all borrowers. Now, banks are required to review their base rates at least once every quarter and ensure that any changes made are passed on to all classes of borrowers.

After the RBI raised its key policy rates in its quarterly monetary policy review on January 25, 2011 several banks have taken the cue and hiked their respective base rate as well as benchmark prime lending rate (BPLR). Borrowers whose loans are currently linked to PLR can take a call on moving to base rate and the bank cannot charge any fee for effecting the transfer. While it is yet to be seen if the new benchmark will indeed benefit old borrowers, many are of the opinion that switching over would certainly result in noticeable gains. For the purpose, you need to get in touch with your bank and inform them that you intend to adopt the new system. There is no standard format prescribed for making the switch. Your bank, though, may ask you to submit the relevant application form or a letter stating your intent. Once you accept the new terms, the bank will have to facilitate the transition.

If you are one of those whose home loan continues to be linked to PLR, you would do well to analyse your current situation before switching to the base rate. For instance, if you are very close to clearing the entire loan, say a year from repaying the entire amount, you need to compare the present home loan rates – the one benchmarked to the base rate as well as the one linked to the PLR. If the latter is lower, you can look at continuing with it. However, if the last instalment due is several years away, you should definitely consider making the switch, even if the PLRlinked rate is lower than the one tied to the base rate. This is simply because the latter is a more transparent mechanism and is likely to reflect changes in the interest rate environment effectively. Lastly, if you have taken a home loan under the ‘teaser’ or ‘special’ home loan schemes that were in vogue till recently , you needn’t take any action at all. Once the fixed-rate period expires, your new rate will be automatically linked to the bank’s base rate then.

Monthly Income - Post Office/Mutual Fund

The post office's monthly income scheme (PO MIS) and the monthly income plans (MIPs) sponsored by mutual funds both offer monthly returns. But which one is better? The government-sponsored PO MIS gives an assured return of 8% payable monthly plus a maturity bonus of 5%, while MIPs offer better liquidity and also returns by deploying 5% to 25% of total assets in equity and the rest in debt products.


What are Monthly Income Plan (MIP) and Monthly Income Scheme (MIS)


Monthly income plans (MIPs) are hybrid mutual fund that invests about 80% to 100% in debt and the rest in equity. The returns are not guaranteed.

The returns of the monthly income scheme from post office are guaranteed by the government of India.

About MIS

MIS assures a return of 8%, plus a maturity bonus of 5% after tenure of six years. The post office website claims that if the monthly interest payments are invested simultaneously in the post office-sponsored recurring deposit scheme (it earns an interest of 7.5% compounded quarterly), the effective yield comes to 10.5%. However, a closure scrutiny suggests this is a marketing gimmick; the effective return on maturity proceeds, inclusive of the bonus amount, turns out to be 8.77%. Also, the interest income is taxable at the hands of investors. So, the yield reduces further. Let us suppose you invested 1,20,000 in MIS where the monthly interest components of 800 are invested in the recurring deposit (RD) scheme, which returns 7.5%, compounded quarterly. So, the RD's maturity amount comes to about 72,806. This, along with the bonus amount of 6,000 (5% of 1,20,000), plus the principal component (a total sum of 1,98,806), gives an effective yield of 8.77%.

About MIP

The MIP also resorts to a marketing gimmick. A monthly income plan would suggest that the schemes offer some returns every month. However, the monthly dividends from such schemes are not guaranteed. Dividends are subject to the availability of distributable surplus and it is solely at the discretion of the fund house. So, if the market goes through volatile times or nosedives for a long period, no dividend may be declared. As MIPs invest 15-20 % in equities, they are subject to market risks. Nonetheless, a good fund manager manages the MIP in an effective manner and takes calculated risks to give steady returns.Inflation

Inflation has always affected the investment continuously eating into our returns. Hence, all investors look for a product that generates alpha over the inflation rate. In the current burgeoning inflation rate scenario, returns do matter. If it comes at a little additional risk, so be it. Senior citizens or persons looking for a fixed monthly return can consider investing in steady performing MIPs with a good track record of doling out monthly tax-free dividends. Ideally, investors looking at monthly payout MIPs for a longer period should invest at ex-dividend NAV on any particular month so that they get more units. As a result, the monthly payouts, ie, monthly dividend yields they get would be high. If monthly dividends are not required, an investor can choose the growth option.

Taxation

The monthly dividends from MIPs are subject to a dividend distribution tax of 13.84% for individuals; however, if you sell the units within a year, the gain, if any, would be subject to your personal income tax slab. If you sell units after a year, a 10% long-term capital gain tax or 20% with indexation would be levied. The interest income on PO's MIS would be subject to your personal income tax slab; so, the 8% fixed return no longer applies here.