Home loans are without doubt the largest debt that an individual shoulders in his or her lifetime. The average home loan size is about Rs 30 lakh and extends for close to 10 years! The interest paid on a home loan could easily run into a few lakhs of rupees. Given the large ticket size and the long tenure of home loans, customers would be well advised to look at the interest rate that they are paying rather than just the monthly instalment. Money saved is money earned!
Credit Score and Pricing
The credit score measures the probability that a person will default on a loan. The credit score itself ranges from 300 to 900 and is generated by credit bureaus after considering several parameters such as payment history of past loans, credit utilisation, types of credit and vintage associated with usage of credit. The higher the credit score, the lower the probability of default, which means that lenders can offer lower rates of interest to such borrowers. A missed payment on a loan or credit card reduces the credit score. Similarly, if a person has a long credit history, he/she is likely to have a credit score. High utilisation of credit limits on cards also indicates that a person is credit hungry and has the effect of lowering the credit score.
Indeed, this is the logic behind risk-based pricing which helps to separate individual customers based on their risk profile and can help them to save money by lowering their interest costs. Even a 0.5% lower rate could translate into savings of lakhs of rupees in interest costs. Needless to add, this is a huge benefit for borrowers. In this context, lenders have started to differentiate between borrowers based on their credit scores.
Is risk based pricing a reality in India?
# Banks are permitted to charge a risk premium as part of the interest rate to arrive at the effective interest rate for a home loan.
# They are also allowed to change interest rates through the tenure of a loan in case of a change in credit profile.
# Some banks like Bank of Baroda, Union Bank of India, Bank of India and Syndicate Bank will rely on credit scores to decide on the interest rate.
Bank of Baroda, which has linked its home loan interest rate grid to credit score bands, also revises rates if there is deterioration in a borrower’s CIBIL score.
Similarly, Syndicate Bank will hike interest rates if there is a drop of over 50 bps in the borrower’s CIBIL score.
That said, the CIBIL score has been known to have a patchy track record whilst differentiating risk. Sometimes, a person with a blemished track record turns out to have a high CIBIL score and vice versa.
What should a customer do before applying for a home loan to get a lower interest rate?
1. Check the CIBIL report and score. Ideally, this should be done much before applying for the loan so as to give the person a chance to resolve any issues that may be present on the report.
2. Avoid applying to multiple institutions for a home loan. The increase in inquiries could diminish your credit score.
3. Negotiate hard with the lender if you have an unblemished track record on your bureau report.
4. Once you avail a home loan, strive to maintain and improve the credit score. This could lower the rate further!
(By Arun Ramamurthy, Industry Expert and Author of India’s first book on Credit Scores)