Borrowers often forget to consider the significant factors that contribute to the determination of home loan interest rates and apply for loans without trying to improve their standing.
Failing to recognise the impact of interest rates levied on your loan amount may hamper your financial standing. Consequently, financial corporations determine this rate of interest applied to home loans based on several factors.
Types of home loan interest rates applicable
There are two types of interest rates which apply to home loans, viz. –
- Fixed-rate of interest
When applicants apply for a credit that has a fixed rate of interest, the interest levied on the loan amount is fixed for the entire tenor. Borrowers will need to pay EMIs based on this interest rate for the loan tenor.
Henceforth, they can decide what equated monthly instalments (EMIs) they have to pay for the entire period.
- Floating rate of interest
It is also known as the adjustable or variable interest rate, and as the name suggests, these interest rates do not remain fixed. Consequently, the EMIs will differ whenever there is a rise or fall in interest rates which are decided based upon the market dynamics. The EMIs can be unpredictable but may be more affordable at times.
Subsequently, the Interest rate for home loans in India is determined by concentrating on the following factors.
These factors are mentioned below –
- Loan to value (LTV)
LTV is the ratio of the approved loan amount to the total property value that you are purchasing. For properties where an applicant needs to construct the house, the price estimation is estimated by the lending institutions.
Borrowers on an average avail up to 80% of the loan amount as the loan and not the complete property value.
Therefore, higher LTV ratio increases the loan amount, which in turn increases the risk factor for the lender. As a result, financial institutions charge a higher rate of interest.
It is always advisable to reduce effective LTV as much as possible.
Home loan borrowers need to pay a part of the property value as a downpayment because financers can pay as much as 80% of the property’s value.
So, if you are able to make a downpayment equal to 30%, you need to avail a lower loan amount and also stand a chance to benefit from lower interest rates. Higher down payments reduce the risk factor for the borrower.
- Repo rate & MCLR rate
Repo rate is the interest rate at which the Reserve Bank of India lends finances to commercial banks. The marginal cost of fund-based lending rate (MCLR) is the lowest rate at which commercial banks and NBFCs lend finances to citizens.
Note that only existing loans with a floating rate of interest are affected by MCLR rate. Subsequently, candidates must weigh both options and choose between floating and fixed interest rates.
Also, the MCLR rate is fixed for a short tenor like 6 months or a year. Therefore, any changes in the MCLR rate are reflected only after reset of this period.
Financial institutions can charge a higher rate of interest for long tenors as the repayment period is extended. Applicants who can afford shorter tenors and higher EMIs may get better home loan interest rates.
Note that equated monthly instalments for a loan are lowered with long tenors even if the cumulative interest charged is high. An applicant can make use of loan EMI calculator to balance between the payable EMIs and the total cost of the loan.
- Annual income and source of income
When candidates have higher annual income and a stable source of income, leading financial institutes may approve loans at competitive interest rates. Stability and amount of income translate into better repayment capability for lenders.
Leading lenders such as Bajaj Finserv offers multiple repayment-friendly benefits such as no-charge part prepayment and foreclosure, property dossier, etc. to such prospective applicants.
Determination of home loan interest rates can be an interesting evaluation for financial institutions but knowing the factors that affect the decision can work in your favour.
Understanding the factors well helps in making a sound decision while choosing the most suitable loan option.
In addition to knowing the determinants of interest rate calculation, home loan interest tax benefit can be claimed as well for the interest paid on loans.