Since lenders consider a range of parameters when setting loan rates for home loans, understanding these factors can help you get a suitable home loan deal with the lowest interest cost. lower depending on your eligibility.
Here are some of the key factors that determine the interest rate on your home loan:
Many lenders have started to adopt risk-based pricing in which they consider the credit rating of mortgage applicants while setting the interest rate on the loan. Since those with a good credit rating are considered creditworthy because of their disciplined repayment history, lenders seduce them by offering them lower interest on home loans. Therefore, those who are considering availing home loans should collect their credit report at least 6 months before submitting their application.
This would give them enough time to take the necessary steps to improve their credit rating before submitting their application. It would also help detect clerical errors or misinformation, if any, in credit reports. Once such an error or misinformation is reported to the relevant office or lender, the corrected credit report will automatically reflect a higher credit score.
Amount of the loan
A higher loan amount can mean higher credit risk for lenders and hence they charge relatively higher interest rates for home loans involving a higher loan amount. For example, the interest rate for SBI home loans for an amount up to Rs 30 lakh starts from 6.75% per annum, while the interest rate for a loan amount greater than Rs 30 lakh and Rs 75 lakh starts at 7.00% per annum and 7.10% per annum, respectively. Therefore, borrowers should try to accumulate a higher down payment or margin contribution if it would help them qualify for a home loan at a lower interest rate.
Interest rate type
Mortgage interest rates are classified into 3 types: floating, fixed and blended interest rate. The floating interest rate varies with changes in the benchmark interest rate followed by the lender, while fixed rate home loans remain constant throughout the term of the loan. When it comes to mixed / hybrid rate home loans, these remain fixed for a predefined term, usually 2 or 3 years, after which they become variable rate home loans. Since blended and fixed interest rates tend to involve higher risks for lenders, banks and HFCs charge a higher interest rate to compensate for their loss of interest income resulting from adverse changes, where applicable, the interest rate regime.
Loan to value ratio (LTV)
The LTV ratio of a home loan is the proportion of the property’s value sanctioned as a loan by the lender. The remaining amount must be financed by your own funds in the form of a deposit. As banks have to make higher allowances for home loans with a higher LTV ratio, they compensate for this by charging a higher interest rate for loans with higher LTV ratios. Therefore, borrowers should try to opt for a lower LTV ratio in order to lower their interest charges.
Many banks and HFCs take home loan applicants’ source of income into account when setting the interest rate. Typically, salaried people are billed at a lower interest rate than self-employed professionals due to the higher income certainty of salaried people. Among salaried applicants, government and PSU employees are most preferred due to greater certainty in employment and income. They are followed by those who work in reputable and important organizations in the private sector, as these companies are considered more stable with a higher potential to withstand economic downturns compared to other companies in the private sector.
Since lenders’ appetite for credit risk and the setting of interest rates tend to vary widely, borrowers should compare as many home loan options as possible before focusing on an offer. They should first approach banks or NBFCs / HFCs with which they have an existing relationship, as many lenders offer preferential interest rates to existing consumers. Then follow up by visiting online financial markets to compare the interest rates offered by other lenders.
(By Ratan Chaudhary, Head of Home Loans, Paisabazaar.com)