Five things to consider while applying for a home loan during falling interest rate regime

The ongoing low interest regime has allowed many banks and HFCs to offer home loan interest rates starting from 6.5 to 7% p.a. With festive season around the corner, many would also plan to avail home loans for purchasing home. However, the big-ticket size and long tenure of home loan demands adequate financial preparedness on part of the applicant to improve their loan approval chances as well loan serviceability at optimum credit cost. Also, there can be multiple reverses in the interest rate regime during the loan tenure, which can increase the repayment burden and interest cost for the borrower.

Here are some crucial check-points for those planning to avail home loan

1. Accumulating down payment or margin contribution

The RBI guidelines allow lenders to finance up to 75-90% of the properties’ value in the form of home loan. The rest of the property’s value has to be contributed by the borrower himself in the form of down payment or margin contribution. Hence, those planning to borrow home loan need to aim at accumulating 10-25% of the home property’s value. Borrowers should always aim at paying a higher down payment as doing so would reduce the interest cost of the home loan borrower. Additionally, making a higher down payment reduces the credit risk for the lender, which thereby increases the probability of loan approval. As some lenders consider LTV ratio while setting the interest rate, a higher down payment can help in availing loan at lower interest rate.

Avoid compromising your emergency fund or investments made for crucial financial goals to make higher down payment or margin contribution. Doing so may force you to avail costlier loans in future to deal with financial emergencies or for other goals.

2. Check your EMI affordability

Lenders usually prefer lending to those whose EMI obligations, including the one for their new home loan, are within 50-60% of their monthly income. Applicants exceeding this ratio have very low chances of availing home loan. Hence, those exceeding this limit should aim at reducing it by either reducing their existing EMIs through prepayment or by making higher down payment. 

 3. Review your credit score

 Lenders consider credit score of loan applicants while evaluating their applications. Those having a credit score of 750 and above usually have higher chances of loan approval. Many lenders have also started offering preferential interest rates to those having higher credit score. Hence, those planning to avail home loan in the near future should aim at building a strong credit score. Fetch credit report at regular intervals and report any discrepancies or errors in the report to the credit bureau for rectification. Practicing disciplined financial behaviour like paying credit bills or EMIs by their due dates, keeping credit utilisation ratio within 30%, monitoring guaranteed or joint loans, etc can help them improve their credit score.

Those having no credit history can build their credit score by availing credit card. Those unable to avail credit card can avail secured credit cards to build their credit score.  

 4. Compare various lenders

 The interest rate, processing fee, loan eligibility, tenure and loan amount offered by different lenders can vary, depending on their credit risk assessment, cost of funds, etc. Hence, it is important to compare home loan offers from as many lenders as possible. The easiest way to do so is to visit the online financial marketplaces and compare the loan offers available from multiple lenders based on your credit score, monthly income, employment profile and other facets of your credit profile. Also, check with banks or NBFCs with which you have existing banking or lending relationships as they may offer concessional interest rates to existing customers.   

5. Maintain an adequate emergency fund

The primary objective of having an adequate emergency fund is to keep money readily available for dealing with unforeseen financial exigencies and/or to meet unavoidable expenses like rent, utility bills, EMI, insurance premiums, children’s tuition fee, etc during period of income loss.

This fund should be big enough to meet unavoidable expenses for at least six months. The amount equalling at least six months’ EMIs of the new home loan should also be included in your emergency fund. This will allow you to continue timely repayment of your home loan EMIs during period of economic or income uncertainty like the one witnessed during the pandemic.

Park your emergency fund in highly liquid instruments like high-yield savings accounts or fixed deposits to ensure instant accessibility. Prospective borrowers can also consider home loan interest saver or overdraft option, a variant of home loan. Under this option, an overdraft account is opened in the form of savings or current account and linked to the loan account.

The borrower can deposit his surpluses in the overdraft account and withdraw from it whenever required. The interest component of home loan account is calculated after deducting the balance in the overdraft account from the outstanding loan amount. Thus, the home loan overdraft option allows the borrowers to use their surpluses for reducing their interest cost while preserving their liquidity for future uncertainties.

(The author is Head of home loans at Paisabazaar.com. Views expressed are personal)