Before applying for a home loan, you must address 4 crucial questions for assessing your financial preparedness for availing the loan.
Home loan is a long-term financial commitment involving a higher loan amount and longer repayment tenure. Initial down payment or margin contribution also require substantial investment by the borrower. In addition to this, lenders consider the credit score and repayment capacity of the borrowers while assessing their credit worthiness. Thus, the possibility of securing a home loan depends on your current financial health.
Before applying for a home loan, you must address 4 crucial questions for assessing your financial preparedness for availing the loan:
Do you have adequate corpus to make home loan down payment or margin contribution?
The RBI allows lenders to finance up to 75-90% of the home property’s cost through a home loan. The remaining amount has to be arranged by the applicant from their own resources in the form of margin contribution or down payment. This ratio of loan amount and borrower’s own contribution is called the LTV ratio. Though most home loan applicants prefer higher LTV ratios, opting for a lower LTV ratio has its advantages.
Choosing a lower LTV ratio results in a lower loan amount, which leads to lower interest cost for the borrower. As lower LTV ratio reduces the credit risk of the lender, opting for a lower LTV ratio enhances the chance of loan approval at lower interest rate. However, opting for a higher down payment at the cost of your emergency fund or redeeming investments made for crucial financial goals must be avoided. Doing so may push you towards availing a loan at higher interest cost later on for meeting crucial financial goals or dealing with unforeseen financial shortages.
What’s your credit score?
Credit score of 750 and above is considered to be ‘good’ by the lenders. Applicants having a good credit score have better chances of securing a loan. Many lenders also offer preferential rates to home loan applicants with a good credit score. Thus, home loan applicants should ideally aim at maintaining 750+ credit score. It is equally important to review credit reports at periodic intervals. This would allow adequate time to take necessary measures for improving and building credit score before applying for a home loan. Following healthy financial habits like paying off credit card bills and existing EMIs on time, maintaining credit utilisation ratio within 30% and avoid making multiple loan or credit card applications within a short span will steadily improve your credit score.
Those with no credit history can build their score by opting for a credit card and repaying dues on time. Those who cannot avail regular credit cards because of inadequate income, risky job profile, unserviceable location, etc can opt for secured credit cards.
Do you have home loan repayment capacity?
Lenders usually prefer lending to those having their monthly loan repayment obligation, including the new home loan’s EMI, within the 50-60% of their monthly income. Those surpassing this limit should ideally foreclose or prepay their current loan obligation to lower their monthly EMI outgo. If doing so is not possible, try to reduce the home loan EMI by opting for a longer home loan tenure.
Applicants should use online EMI calculators to estimate optimum EMI for a new home loan after factoring in their repayment capacity and monthly investments. Being aware of your repayment capacity would help reduce the chance of defaulting or compromising on other goals.
Have you included your expected home loan EMI in your emergency fund?
Loss of income due to job loss, illness or disability can adversely impact your loan repayment capacity. Defaulting on home loan EMIs would attract heavy penalty and negatively impact your credit score and future loan eligibility. On the other hand, liquidating your existing investments for repaying home loan EMIs can hamper your long-term financial health. The best way to ensure timely home loan repayment during financial emergencies is to include at least six months’ EMI obligation while setting aside your emergency fund.
(By Ratan Chaudhary, Head of Home Loans, Paisabazaar.com)