WITH low interest rates likely to continue for some time, people need to understand various aspects of their home loans. A key factor is interest rate and borrowers need to understand how banks calculate lending rates and its impact on home loans.
Calculating interest rate
Home loans were earlier linked to the RBI-prescribed base rate, which is now replaced with MCLR (Marginal Cost of Lending Rate). Any rise or fall in the CRR, repo rate, reverse repo rate, SLR has a direct impact on the MCLR and hence on the home loan interest rate. However, MCLR is applicable to only banks and is a tenor-based benchmark system instead of a single rate. This allows banks to efficiently price loans at different tenors based on different MCLRs, according to their funding composition, operational strategies and business model. Two typical scenarios arise for new applicants who can now leverage the lower rate regime and older borrowers who are exploring how revised lower rates impact their EMIs and if they should move their loans. To make the most of a falling interest rate scenario, it’s advisable for legacy borrowers to switch only after doing a cost and benefit analysis for the whole tenure.
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Fixed vs floating
A new applicant, before applying for a loan, can explore a fixed or floating interest rate as both have advantages and disadvantages. While a borrower opts for a fixed rate only when prevailing interest rates have reached rock bottom and an upward trend is anticipated, a floating rate varies with market lending rates and is prone to fluctuations.
The EMI may vary based on the rate movement, keeping the tenure unchanged. In the current scenario, it is advisable for borrowers to opt for a floating rate. Financial institutions, especially housing finance companies, provide an alternative to raising the tenure of the loan and offer customised products to borrowers who wish to limit their EMIs.
Your CIBIL score
Financial institutions consider key factors like the CIBIL score, loan amount and loan tenure, to arrive at a lending rate. The CIBIL score, indicating creditworthiness, is considered by some financial institutions in the loan application process. This is a three-digit numeric summary of the borrower’s credit history and works as a first impression for the lender. The higher the score, the better are the borrower’s chances of being offered attractive interest rates.
To ensure better credit history, borrowers should adhere to timely payments. Dispute over non-payment may impact credit history. Loan amount has a bearing, too, as generally a lower loan amount, especially for affordable housing projects, attracts a lower rate.
The writer is CEO, DHFL