Home loan borrowers will tell you that the interest rate offered makes the biggest difference to how easy or difficult it will be for anyone to repay the loan. High home loan interest rates not only make EMIs difficult to pay but also increase the total interest outgo. On the other hand, low home loan interest rates allow borrowers to repay their loan in a comfortable and stress-free manner while also saving on the total interest pay-out over the tenor of the loan. To understand, how home loan interest rates affect EMIs, let us dig into the EMI calculation formula.
Here’s How Home Loan Interest Rates Affect Your EMIs
To be able to answer this question, we must first look at the EMI calculation formula.
EMI = P x R x (1+R)^N / [(1+R)^N-1]
Here,
P is the principal loan amount or your loan value
N refers to loan tenor in months. So, if you are planning to take a loan for 5 years, your loan tenor would be 5×12, which is equal to 60 months.
R is the monthly interest rate.
Looking at this formula, it is easy to understand that the rate of interest directly impacts one’s EMIs — the higher the rate of interest, the higher will be one’s home loan EMIs. Borrowers must therefore try their best to avail of the lowest home loan interest rates possible. In this regard, developing an understanding of the factors that affect home loan interest rates is crucial. Let us look at them.
Factors that Affect Home Loan Interest Rates
Here are the factors that have a major impact on home loan interest rates.
Credit Score
An individual’s credit score is one of the key factors that affects the home loan interest rates they will get. The higher one’s credit score or the closer it is to 750, the better one’s chances of securing low interest rates. High credit score indicates excellent repayment potential and in general, a responsible attitude towards credit. Thus, lenders extend their best home loan deals and lowest home loan interest rates to individuals with a high credit score.
Loan-to-Value Ratio
The loan-to-value ratio refers to the maximum loan value that can be taken with respect to the total value of a property. Higher loan-to-value ratio indicates low stake of the borrower in the loan and property and therefore, higher risk for the lender. On the other hand, a low LTV ratio indicates low risk for the lender. Borrowers opting for a low LTV ratio often get low interest rates.
Income Stability
The borrower’s income profile is another key factor that determines the rate of interest that will be offered to a borrower. Lenders sanction lowest interest rates to borrowers with stable jobs and good income profile or young borrowers who still have many working years ahead of them.
Type of Interest Rate Opted For
In India, lenders allow borrowers to choose from two different types of interest rates: fixed and floating. In the case of fixed interest rates, the rate of interest stays the same through the tenor of the loan. In the case of floating interest rates, the interest rate varies depending on external market conditions.
For lenders, risk involved in lending money at fixed interest rates is higher than the risk involved in lending money at floating interest rates. This is why fixed interest rate home loans tend to be more expensive than floating interest rate home loans.
Quality of the Property
The interest rate offered to a borrower also depends on the type of property they are planning to buy with the borrowed amount. When borrowers use the loan money to invest in centrally-located properties with all modern amenities, they get offered a low interest rate as these properties have high resale value and therefore, the risk involved for the lender is offset by the high value of the collateral involved. On the other hand, when the collateral involved is an old property, the lenders also offer a high interest rate on the loan.
Tenor of the Loan
Lastly, the interest rate offered to a borrower also depends on the tenor opted for by them. When borrowers opt for a short tenor, the risk involved for the lender in lending money is low and therefore, lenders sanction short tenor loans at a low rate of interest. On the other hand, long tenor loans often at high rate of interest.
Final Words
The rate of interest offered on a home loan directly impacts the loan EMI as well as the total cost of borrowing the loan. The higher the rate of interest, the higher will be the EMIs and vice versa. Thus, borrowers must try their best to avail of the lowest interest rate possible. This is possible only when one has a thorough understanding of the factors that affect home loan interest rates. Through this article, we have tried to extend to help to our readers in this regard. Hope you find the article insightful.