What does the average person have to do with rate cuts? How does a rate drop affect your pocket?

After a long gap of nearly four years, the US Federal Reserve has finally taken a major decision and announced a cut in the policy rate (US Fed Rate Cut). As per the forecast, the rate has been reduced by 50 basis points or 0.50%. The decision to change the interest rate has been taken as inflation has been brought under control. After this, all kinds of loans are expected to decrease. But do you know how the policy rate or repo rate affects the loan EMI or savings in any country? Let us understand what the rate cut means for the common man?

U.S. decision could add pressure on India’s central bank
First, let’s talk about the Fed’s announcement. Although the Fed has already lowered interest rates to 4.75% to 5%, there are also signs that further rate cuts will be coming soon. We told you that the policy rate has been at 5.25% to 5.5% for a long time. While announcing the rate cut, Fed Chairman Jerome Powell said that there would be no delay in the rate cut.

He further said that despite the 50 basis points reduction in interest rates, the work of fighting inflation is not over yet. It is expected that after many countries including the United States have cut interest rates, India may also face pressure to reduce the repo rate as the country’s repo rate has remained stable for a long time while inflation has been within the prescribed range. However, the final decision will be taken by the Reserve Bank of India (RBI). It is worth noting that India’s interest rate or repo rate has been stable at 6.5% for a long time. The issue can be decided at the next meeting of the six-member Monetary Policy Committee of the Indian Central Bank. This meeting will be held from October 7 to 9 next month.

Calculating inflation directly from interest rates
Be it the US, India or any other country, everyone has to manage inflation and interest rates. Central banks around the world increase repo rates to reduce inflation peaks and usually ease the pressure by reducing repo rates when inflation subsides. To understand the connection in clear words, the whole game is about supply and demand in any economy. If demand increases and supply decreases in the country, inflation will increase.

In order to control inflation, the central bank took measures to increase the policy interest rate to reduce market liquidity, and then all banks increased their lending rates. As a result, customers received fewer loans and market liquidity also decreased. This meant that since loans became expensive, cash flow in the economy fell, demand decreased, and inflation began to be controlled. Thereafter, the banks insisted on reducing interest rates.

The impact of changes in repo rates on loans
When the repo rate changes, there is a hope that the loan becomes cheaper and it is said that the bank will now reduce the interest rate on the loan. For this, it is very important to understand the relationship between the interest rate and the EMI of the loan. So, let us tell you that all other bank loans, including home loans, personal loans, and car loans, are linked to the repo rate.

Repo rate is actually the rate at which the Reserve Bank offers loans to other banks. So, when the repo rate goes up, banks get loans from the Reserve Bank at expensive rates. Hence, the loans available to the common people also become expensive. At the same time, when it goes down, banks also reduce the interest rates on their loans and hence, the loan EMIs also go down accordingly.

Understand the impact on EMI through calculation
Let us understand how an increase or decrease in the repo rate or policy rate affects the EMI of a loan through an example. Suppose you have taken a housing loan of Rs 30 lakh for a period of 20 years at an interest rate of 6.7%. The repo rate is stable at 4%. At this rate, your monthly EMI would be Rs 22,722. But now the interest rate is 6.5%, which is an increase of Rs 2.50, so if the bank increases the repo rate accordingly, the interest rate on your loan will also increase to 9.2%. In this case, your EMI will also increase to Rs 27,379 per month. This obviously means that the burden on your pocket increases by Rs 4,657 per month due to EMI charges. If it is less than this rate, then the EMI will also be reduced.

It also affects the FD interest rate
On one hand, the impact of the increase in repo rate on loan EMI is obvious, on the other hand, the interest rate on savings account has also changed. If we look at the country since the COVID period, due to rising inflation, on one hand, the RBI has increased the repo rate several times, on the other hand, banks have increased the cost of loans to attract customers. Fixed deposit (FD) interest rates have risen sharply. Today, government banks offer 7-8% interest rates, while some small finance banks offer interest rates as high as 9%.