Understanding the Factors that Influence Home Loan Interest Rates

When it comes to financing the purchase of a property, home loan interest rates play a seismic role. They can be the difference between saving or spending lakhs of rupees.

Understanding the factors that influence interest rates is crucial for any prospective homeowner. The interest rate on your home loan determines the overall cost of your mortgage, impacting both your monthly payments and the total amount repaid over the loan's tenure.

Let's delve into the key factors that can sway home loan interest rates, exploring how they affect borrowers and their financial decisions.

1. Loan Amount

The loan amount can dictate the home loan interest rates offered due to its direct correlation with credit risk. Larger loan requests often imply increased risk for lenders, which may lead to adjustments in interest rates.

As the loan amount rises, the Loan-to-Value (LTV) ratio tends to increase, affecting risk perception. Affordability and loan slabs further contribute to the nuanced relationship between loan amounts and interest rates.

Economic factors and negotiating power also play a role, making the loan amount a pivotal factor in shaping the cost of homeownership.

2. Marginal Cost of Lending

Another fundamental factor influencing home loan interest rates is the Marginal Cost of Funds based Lending Rate (MCLR). This benchmark rate is set by banks keeping in line with the RBI , essentially determining the minimum interest rate at which they can lend.

Banks consider factors like operating costs, marginal cost of funds, Cash Reserve Ratio (CRR), and tenor premium when they set the MCLR. Keep in mind that MCLR rates can change, and impact the interest rates on existing home loans.

Borrowers who opt for floating interest home loans will naturally be affected by periodic reviews and changes of MCLR.

3. The Type of Interest Chosen

Homebuyers often have the option to choose between fixed, floating, or mixed interest rates. Floating rates are subject to changes influenced by the Reserve Bank of India (RBI).

As mentioned, banks may adjust rates based on RBI norms, affecting borrowers' Equated Monthly Instalments (EMIs). On the other hand, fixed rates remain constant throughout the loan tenure, offering stability. Mixed interest rates typically start with a fixed rate before transitioning to a floating rate.

Reach out to your bank or visit their website to check out various interest rate options, and select a plan that aligns with your finances.

4. Credit Score

A crucial determinant of home loan interest rates is the borrower's credit score. This numerical representation of one's creditworthiness is influenced by repayment history and financial discipline.

A higher credit score often leads to lower interest rates, reflecting the borrower's lower credit risk. Leading banks in India offer relaxed interest rates to applicants with credit scores over 750/800.

5. How Much You Earn

Banks typically set minimum income criteria based on the borrower's city of residence. Usually, these are around Rs 20,000 a month. Meeting this criteria enhances the borrower's eligibility for a home loan. For instance, a higher income may qualify borrowers for larger loan amounts with competitive interest rates.

Banks may even offer other benefits, such as low-interest top-up loans, based on the applicant's income and loan amount.

6. How You Earn

Stability of income is a key factor affecting interest rates. Borrowers with stable income sources, such as salaried professionals, government employees, and those in reputable private sector firms, are considered low-risk. This may result in lower interest rates compared to individuals with less stable income sources.

Self-employed non professionals may be offered different terms on their home loans. Even where you work comes into play, whether you work in an established multinational or a startup can also play a part.

7. The Home Loan Tenure

The loan tenure plays a pivotal role in determining interest rates. Loans with shorter tenures often attract lower interest rates, despite higher EMIs, compared to longer tenure loans.

Borrowers can use online home loan EMI calculators to find the optimal tenure based on their financial preferences. You can see how the tenure and loan amount influence interest rates using Home Loan EMI Calculators on the websites of leading banks.

8. Relationship with the Lender

Being a customer with a lender can be advantageous when seeking a home loan. Existing customers who have demonstrated financial responsibility by repaying previous loans promptly or maintaining healthy banking relationships may be eligible for pre-approved offers. These offers often come with streamlined processes, requiring fewer documents and come through at competitive interest rates.

Loyal customers can leverage their history with the bank to negotiate favourable terms, showcasing the value of sustained financial partnerships in securing more accessible and cost-effective home loan options.

9. Balance Transfer and Negotiation

Borrowers holding existing home loans can explore avenues to optimise their interest rates. Consider the option of a Balance Transfer to a new lender offering more favourable rates.

Additionally, proactive borrowers can engage with their existing financiers to negotiate and potentially lower the rate of interest.

For More Affordable Home Buying

These factors are the architects of home loan interest rates, and determine the affordability of homeownership. Prospective homebuyers should meticulously weigh these elements and partner with banks aligning with their financial aspirations.

Recognise that while some factors are controllable, others sway with economic currents. Armed with insights, borrowers can secure home loans tailored to their budgets and financial goals.

Disclaimer: The interest rate examples and terms used in this article are illustrative and not specific to any particular bank. Actual rates may vary based on individual banks, their policies, and prevailing economic conditions.