Important Factors that Affect Your Home Loan Interest Rate

By IIFL Home Loans | December 18, 2023 1 min

Buying a home with a mortgage is a major undertaking, and the interest rate you pay can be the difference between an affordable monthly budget and a long-term drain on your finances. Interest rates in India do not remain the same. They are affected by a number of personal, economic and institutional factors. If you know these things, you will be able to negotiate a better deal and save yourself a lot of money over the life of your loan.

How Do Home Loan Interest Rates Work?

A home loan interest rate is essentially the price you pay to borrow money from a lender. Banks and housing finance companies (HFCs) decide the rate based on their cost of funds and the risk they assess in lending to you.

Today, most home loans in India are floating-rate loans which are linked to an external benchmark, typically the Reserve Bank of India (RBI) Repo Rate. When you borrow money, the bank adds a spread or margin to this benchmark. This means that if the RBI raises the repo rate, your interest rate goes up, and if it cuts, your rate generally goes down. Fixed-rate loans are less common and tend to begin at a higher rate, but the rate stays the same.

Key Factors That Affect Your Home Loan Interest Rate

Here are some of the key factors that impact your home loan interest rate.

Your Credit History and Credit Rating

Your credit score (usually CIBIL score) is perhaps the most important factor. It's a report card of your financial behaviour in the past. Lenders consider a score of 750 or higher to be an indicator that you're a low-risk borrower and qualify for the lowest interest rates available. By contrast, a lower score means missed payments and/or high debt, which leads lenders to add a risk premium (more interest).

Loan Amount & Loan Tenure

It may seem counterintuitive, but the size of the loan and the time it takes to pay it back are important. Big loans are generally considered risky. Similarly, a longer tenure reduces your Equated Monthly Instalment (EMI). Still, it increases the lender's exposure to long-term economic changes, and they may charge a slightly higher interest rate than for a short-term loan.

Fixed/Floating Interest Rate

Floating rates are generally lower than fixed rates. But they do have the risk of market volatility. Fixed rates provide peace of mind by shielding you from future interest rate increases. However, fixed rates tend to be more expensive because the lender is assuming the risk of varying interest rates for you.

Nature of Employment and Income Security

Lenders like borrowers with predictable, stable income. Salaried professionals are often considered a lower risk, especially those working for well-known government organisations or large private firms. Freelancers might have a harder time proving the stability of their business, and they might face higher interest rates unless they can show a track record of consistent profits.

Internal Risk Assessment of the Lender

Each bank or HFC has its own internal policy. Lenders can specialise in "prime" borrowers with good credit scores and low interest rates, or they can specialise in riskier borrowers and charge a higher rate to offset the risk.

Place and Description of the Property

The property is the security for the loan. Banks look at safer properties in good, well-established areas with high resale value. In contrast, if the property is located in an underdeveloped neighbourhood or has some legal complications in its history, the lender might see it as a high-risk asset, and this can lead to a higher interest rate for you.

Existing Debt Obligations (FOIR/DTI Ratio)

Lenders will work out your Fixed Obligation to Income Ratio (FOIR) or Debt-to-Income (DTI) ratio. If you already have several loans in progress (personal loans, car loans, etc.), then a large part of your monthly income is already committed. A high FOIR is a sign of financial stress and can result in higher interest rates or outright rejection of a loan.

Market Conditions and RBI Policy Rates (Rate of Repo)

When the RBI hikes the repo rate, it becomes costly for banks to borrow money. They usually charge these costs to borrowers. Interest rates are generally higher during periods of economic growth or high inflation.

Loan-to-Value (LTV) Ratio

The LTV ratio is the percentage of the value of the property that the bank will lend. The more you put down, the lower your LTV ratio. The lower your LTV ratio is, the less risk the lender is taking and the more likely they are to offer you a more competitive interest rate.

Tips to Get a Lower Home Loan Interest Rate

Let's understand some essential tips to get a lower home loan interest rate.

Increase Your Credit Score: Make sure to pay your bills and existing EMIs on time for at least 6–12 months before applying for a home loan.
Raise Your Down Payment: A larger down payment means a smaller loan, lower LTV, and a more attractive profile to lenders.
Compare Lenders: Interest rates can be anywhere from 0.25% to 1% between institutions. Use online comparison tools always.
Hold a Stable Position: Don't change jobs or business ventures right before you apply for a loan.

Why Interest Rates Vary Between Lenders

Different lenders have different costs of funds, i.e. interest they pay to depositors and the RBI. And they also have different customer segments. A big public sector bank may prefer low-risk, stable borrowers, while a specialised HFC may be more flexible with self-employed borrowers but may charge higher interest rates to cover higher risk.

Conclusion

Buying a home is a big financial commitment, and the right home loan can make the journey easier. Improving your credit profile, maintaining stable finances, and comparing loan options can help you secure better borrowing terms.

IIFL Home Loans provides attractive rates of interest, flexible repayment options and a simple application process tailored to your financial needs. If it's your first time buying a home, moving up to a new property or transferring an existing loan, our transparent approach and expert help will ensure a smooth borrowing experience. We help you achieve your homeownership goals through fast processing and customer-focused service.

Frequently Asked Questions (FAQ’s)

Does income from your spouse help you get a lower interest rate?

Ans:

Adding a co-applicant can boost your household income profile and FOIR, helping you qualify for a larger loan or better terms, but it doesn’t directly lower the interest rate.

Is the interest rate on a balance transfer better than a new loan?

Ans:

Yes, often. The idea behind balance transfers is to shift your loan to a lender offering a lower interest rate, which can substantially reduce your interest expenses for the rest of the loan tenure.

Do rates change for existing borrowers?

Ans:

Yes, if you have a floating rate loan, your rate is linked to an external benchmark. Your interest rate will be reset whenever the bank revises its benchmark rate (usually after the RBI moves).

Can I negotiate my interest rate with the bank?

Ans:

Yes, particularly if you have a high credit score, are in a long-term relationship with the bank, or have a large down payment. Don't be afraid to ask for a better rate.

What is the minimum credit score for the best interest rates?

Ans:

A CIBIL score of 750 and above is generally considered to be excellent and is most likely to help you qualify for the lowest interest rates offered by top-tier lenders.