For banks, the prime determinants of their home loan interest rates are their spread and credit risk premium charged over their external benchmark rates. For Housing Finance Companies (HFCs), it is usually their cost of funds. Some of the large HFCs like LIC Housing Finance, HDFC, etc, having access to low-cost funds, are able to offer home loans at lower interest rates than some PSU banks and most private sector banks. However, lenders also consider the credit profile of their home loan applicants while setting their interest rates. An understanding of how one’s credit profile can impact his home loan interest rates can help him in availing of home loans at lower interest rates.
Here I will list some factors determining your home loan rates:
Credit score
As with most loan products, lenders consider the credit score of home loan applicants for evaluating their creditworthiness. However, as a part of risk-based pricing, many home loan lenders are now factoring in the credit scores of their home loan applicants while fixing their interest rates. Those with credit scores of 750 and above are usually considered as more creditworthy and hence, lenders try to entice such loan applicants by charging them lower interest rates. Similarly, as credit scores below 750 are usually considered as a sign of financial indiscipline and higher credit risk, home lenders try to compensate for the higher credit risk by charging higher interest rates for such home loan applicants.
Hence, those planning to avail of home loans in the near future should fetch their credit reports at least 6 months prior to applying for home loans. This would provide them adequate time to take corrective measures for improving their credit score. This would also help in detecting wrong information or clerical errors, if any, in their credit report adversely impacting their credit score. Once such errors or wrong information are reported to the concerned bureaus or lenders for rectification, the rectified credit report will automatically register a higher credit score.
Loan amount
A bigger loan amount increases the credit risk for the lenders. Hence, many home loan lenders charge higher interest rates for bigger loan amounts to compensate for their higher credit risk. Thus, home loan borrowers should try to pay a down payment or higher margin contribution if it helps them in availing of home loans at lower interest rates.
Interest rate type
Lenders offer three subtypes of home loan interest rates – fixed, floating, and fixed interest rates. Interest rates of home loans availed at floating interest rates change as per the changes in the benchmark interest rate followed by the lender. In the case of fixed-rate home loans, the interest rate remains constant during the entire loan tenure. As far as mixed-rate home loans are concerned, interest rates remain fixed for a pre-determined period, usually for initial 2 or 3 years of home loan tenure, after which the mixed-rate home loan transition into floating rate home loans. As fixed and mixed interest rates increase the interest rate risk for the lenders, home loan lenders usually charge higher interest rates to cover the possible loss in interest income caused by an increase in the broader market interest rates, in the future.
LTV ratio
LTV (Loan to value) ratio of a home loan refers to the proportion of the home property’s value financed through home loans. The remaining amount of the property value has to be arranged by the home loan borrowers through their own funds in the form of a down payment or margin contribution (in case of property construction). As lower LTV ratios reduce the credit risk for the lenders, many home lenders tend to encourage lower LTV ratios by offering lower interest rates to home loan applicants opting for lower LTV ratios.
Job profile
Many banks and HFCs consider the income sources of their home loan applicants while fixing their interest rates. Salaried individuals are usually offered lower interest rates than self-employed individuals. Salaried applicants have higher income certainty and hence, carry lower credit risk for the lenders. Among the salaried loan applicants, government and PSU employees are offered lower interest rates due to their higher income and job certainty. They are followed by loan applicants working in large and reputed private sector organizations.
Tip: Compare interest rates from a diverse set of lenders
The interest rates of home loans vary widely across lenders because of their varying credit risk appetite, cost of funds, and parameters used for setting interest rates. Hence, those planning to avail of home loans should compare home loan offers from as many lenders as possible before choosing any particular lender. They should start the process by approaching banks or HFCs with whom they already have an existing deposit or lending relationship. Many home loan lenders offer preferential interest rates to their existing consumers. These should be followed up by visiting online financial marketplaces to compare the home loan interest rates and other features offered by other lenders based on their credit score, loan amount, LTV ratio, income, job profile, and other eligibility criteria.