How Does Your Credit Score Affect Your Home Loan?

Owning a home ranks high on the aspiration list of Indians. It is considered as a mark of social status and security as well. In line with the need for more and more houses, the real estate prices in the country have seen a massive uptrend over the past few years. This has made owning a home a very costly proposition, which might be difficult without the aid of a home loan for most of the individuals.

A home loan is a big-ticket and long-term loan. Hence, the lenders follow stringent eligibility criteria to ensure that there are no defaults on the loan. They are very particular about the income, employment status, length of employment with the current employer, residential status, existing loans, and your credit score.

Among all other factors, your credit score assumes a huge role in deciding the approval of a home loan. A credit score is an indicator of the past creditworthiness of an individual. It is a three-digit number in the range of 300-900 and is assigned based on the credit behavior of an individual in the past. Higher numbers on the range indicate better levels of creditworthiness.

What Are The Various Factors That Go Into The Calculation Of A Credit Score?

• Your Borrowings: Your earlier loans and credit cards matter. The main factor that is taken into account is that if your earlier credit accounts are repaid or in default.
• Prompt Repayments on Existing Borrowings: It is not only about if the repayments are being made, but also about how regular you are with your existing borrowings. A highly regular repayment schedule will earn you a good credit score.
• Credit Utilization Ratio: This is the ratio of your credit card spending to the total credit limit on the card. A credit utilization ratio of below 30% is considered to be ideal. If you have been regularly spending amounts much higher than that, your credit score may be in jeopardy.
• Credit Mix: Borrowings can be secured or unsecured in nature. Secured loans come with a backing of a security (Home or Vehicle Loans), while unsecured borrowings are personal loans or credit cards that do not have a collateral. A good mix of both the types of borrowings is desirable. Too many unsecured loans in the credit portfolio may not bode well for your credit score.
• Length of Credit History: Lenders prefer to lend to those who are experienced with handling credit. Therefore, a good length of credit history matters.
• Number of Previous Hard Inquiries: Whenever you apply for credit, your lender pulls out your credit score and credit history from the Credit Bureau, which is called a Hard Inquiry. Increased number of such inquiries put the applicant at risk of a low credit score as he/she is perceived to be a credit hungry person.

What is the Credit Score Required for a Home Loan Application?

An applicant with a low credit score does not evoke much confidence in the lender about prompt repayment of the loan. This is especially true of a home loan, as loan amounts and tenures involved are bigger and longer. Therefore, only high credit score of 750 has become a mandatory requirement for those applying for a home loan.

Additional Reading: How bad is your credit score?

How does Your Credit Score Affect Your Home Loan?

In a normal scenario, a lender takes a risk by lending to the borrower and the borrower compensates the risk by paying an interest on the sum borrowed.

When an individual has a low credit score, the lender has to assume a higher risk in lending to that individual. The higher risk involved in lending can get manifested in a number of ways as below.

Rejection of a Home Loan Application

A low credit score can often lead to a complete rejection of a home loan application. If a low credit score is also coupled with low income or higher levels of debt, it makes for a sure shot case of loan rejection. Even when the other factors like employment and income are on satisfactory levels, a very low credit score like that in the below 500 level may result in a home loan rejection.

Even though a home loan may get rejected, it will still be counted as a Hard Inquiry against your PAN. So, this may bring your credit score further down. When you apply for a home loan with a low credit score, you may be in for a double whammy.

On the other hand, a good credit score may ensure that your loan application is approved at the earliest.

Therefore , it is advisable to check your score much before you decide to apply for a home loan, or for that matter, any loan. In fact, checking and improving your credit score should be done simultaneously with house hunting, so that by the time you finalise your home, your credit score could have improved as well.

Approval of Home Loan Application at a Higher Rate of Interest

If your credit score is somewhere in between 650-750, you may still earn an approval on your home loan rate, however the rates of interest will be higher than the ones that are offered to individuals with a credit score above 750.

Risk-based credit pricing in India is already evident. Several top-notch banks like SBI and others follow this methodology.

For Ex: For all home loans above Rs 30 lakhs, SBI has a risk-based grading system which takes into consideration factors such as credit score. The below given rates are only for salaried applicants.

Though the difference in the rates between risk grades may be small, it may prove to make a big difference in the amount of interest paid over the entire term of the loan.

Approval Of Home Loan Application At Other Unfavorable Terms

The rate of interest charged and the tenure of the loan are the main determinants of a home loan EMI. Currently, home loan tenures can go up 30 years depending upon the age of the applicants. However, in the case of an applicant who has a lower credit score, the lender may not want to take the risk of lending for a longer term and hence, may approve the loan for a shorter tenure. Or the lenders may lower the Loan to Value Ratio and ask the applicant to bring in a higher down payment amount.

Both these cases, a shorter tenure or a higher down payment, could in-turn translate to a higher financial burden on the applicant.

End Note

Your credit score, whether good or bad can have far reaching consequences on a home loan. Therefore, it is good to ensure that you have a good credit score before applying for any loan.