Top Factors That Influence Home Loan Interest Rates

With home loan tenures extending up to 30 years, even a small difference in interest rates can lead to a significant impact on the overall interest cost. Since lenders consider multiple factors while determining home loan rates, understanding these factors can help you secure a deal with the lowest possible borrowing cost.

Here are some important factors that determine your home loan interest rates, helping you secure a suitable deal with the lowest overall interest cost.

1. Credit Score

Lenders factor in the credit scores of their home loan applicants while setting their interest rates. As those with good credit scores are considered more creditworthy, lenders try to entice them by charging lower interest on home loans. Similarly, as those with credit scores of below 750 are usually considered to be lacking in credit discipline, lenders try to compensate for higher credit risk by charging higher interest rates.

Therefore, financial planners advise prospective borrowers to fetch their credit reports at least six months before submitting a home loan application. Doing so would give you sufficient time to take the required measures to improve your credit score. It would also help you detect clerical errors or wrong information, if any, in your credit report, which could drag down your credit score. Once you report such errors or wrong information to the concerned credit bureau or lender, the rectified credit report will automatically lead to a higher credit score.

2. Loan Amount

Higher loan amounts do generally increase the lender’s exposure and potential loss in case of default. Therefore, some lenders may price in a slightly higher interest rate to compensate for that higher credit risk. Hence, borrowers should try to pay a higher down payment if doing so helps them to avail themselves of a home loan at a reduced interest rate.

3. Interest Rate Type

Interest rates for home loans are classified into three categories - floating, fixed and mixed interest rates. Floating interest rate fluctuates as per the changes in the interest rate benchmark followed by the lender, whereas interest rates of fixed-rate home loans remain constant during the entire loan tenure.

Interest rates of mixed rate home loans remain fixed for a set period, usually for a period of 2 to 3 years, after which they transition to floating rate home loans. As mixed and fixed interest rates have higher interest rate risk for the lenders, banks and HFCs charge higher interest rates on them to compensate their loss in interest income due to adverse change, if any, in the interest rate regime.

4. LTV Ratio

LTV (Loan to Value) ratio of a home loan is the proportion of the property value sanctioned as a loan by the lender. The remaining amount has to be financed through your own funds in the form of a down payment. As banks have to make higher provisions for home loans with higher LTV ratios, they compensate for such higher provisioning by charging higher interest rates for loans with higher LTV ratios. Hence, borrowers should try to opt for a lower LTV ratio to reduce their interest cost.

5. Job Profile Of Borrowers

Many banks and HFCs also consider the income sources of home loan applicants when setting their interest rate. Generally, salaried individuals are charged a lower interest rate as compared to self-employed professionals due to the higher income certainty of the salaried individuals.

As the credit risk appetite of lenders and their parameters for setting interest rates can vary widely, make sure to compare as many home loan options as possible before making the final application. Start by approaching banks or other lenders with whom you have existing relationships, as many lenders offer preferential rates to their existing consumers.

Follow it up by visiting online financial marketplaces to compare the interest rates offered by other lenders based on your credit score, income, job profile, loan amount and LTV ratio.