Home loan is a long-term financial commitment involving a larger loan amount and a longer repayment term. The initial down payment or the margin contribution also requires a substantial investment on the part of the borrower. In addition to this, lenders take into account the credit rating and repayment capacity of borrowers while assessing their creditworthiness. Thus, the possibility of obtaining a home loan depends on your current financial health.
Before applying for a home loan, you must answer 4 crucial questions to assess your financial preparation for obtaining the loan:
Do you have sufficient corpus to make the down payment or the mortgage line of credit contribution?
The RBI allows lenders to finance up to 75-90% of the cost of the property through a home loan. The remaining amount must be paid by the applicant from his own resources in the form of a contribution to the margin or on account. This ratio between the loan amount and the borrower’s own contribution is called the LTV ratio. While most home loan applicants prefer higher LTV ratios, going for a lower LTV ratio has its advantages.
Choosing a lower LTV ratio results in a lower loan amount, resulting in lower interest charges for the borrower. As a lower LTV ratio reduces the lender’s credit risk, opting for a lower LTV ratio increases the chances of loan approval at a lower interest rate. However, avoid opting for a larger down payment at the expense of your emergency fund or buying back investments made for critical financial purposes. This can lead you to get a loan at a higher interest cost later on to meet critical financial goals or face unforeseen financial shortages.
What’s your credit rating?
A credit score of 750 and above is considered “good” by lenders. Applicants with a good credit score have a better chance of getting a loan. Many lenders also offer preferential rates to mortgage applicants with good credit. Thus, home loan applicants should ideally aim to maintain a 750+ credit score. It is also important to review credit reports at regular intervals. This would leave enough time to take the necessary steps to improve and strengthen the credit rating before applying for a home loan. Follow healthy financial habits, such as paying existing credit card bills and IMEs on time, keeping a credit utilization rate below 30%, and avoiding multiple loan or credit card applications in a short time period of time will steadily improve your credit rating.
Those without a credit history can build their score by opting for a credit card and paying off dues on time. Those who cannot avail regular credit cards due to insufficient income, risky job profile, unusable location, etc. can opt for secured credit cards.
Do you have a mortgage repayment capacity?
Lenders generally prefer to lend to those who have their monthly loan repayment obligation, including the EMI of the new home loan, within 50 to 60% of their monthly income. Those who exceed this limit should ideally exclude or prepay their current loan obligation to reduce their monthly IME expenses. If this is not possible, try to reduce the EMI of the mortgage by opting for a longer loan term.
Applicants should use the online EMI calculators to estimate the optimal EMI for a new home loan after taking into account their repayment capacity and monthly investments. Being aware of your repayment capacity would help reduce the risk of default or compromise on other goals.
Have you included your planned EMI home loan in your emergency fund?
Loss of income due to job loss, illness or disability can negatively impact your loan repayment ability. Failure to pay home loan IMEs would result in hefty penalties and negatively impact your credit score and future loan eligibility. On the flip side, liquidating your existing investments to pay off home loan EMIs can hurt your long-term financial health. The best way to ensure quick home loan repayment in a financial emergency is to include at least six months of EMI bond while setting aside your emergency fund.
(By Ratan Chaudhary, Head of Home Loans, Paisabazaar.com)