Buying a home is a big investment decision and taking a home loan further turns it into a major financial commitment. When looking for a home loan, you need to consider one of the most important aspects: interest rate. The home loan interest rate is acrucial aspect of the loan. Even a slight upwardchange in the rates can make your loan costly.

Have you wondered how interest rate is determined for your home loan? Why is there a difference in the interest rates every few years? Why do you have to pay a higher interest than your friend? This article could help you get an overview of home loan interest rates.

Here is a detailed guide on home loan interest rates.

Types of interest rate

There are three types of home loan interest rates- floating, fixed and mixed interest rates. A fixed rate of interest remains constant for the whole loan tenure irrespective of any external factors. On the other hand, the floating rate is linked to the market rates. If the market rate rises, your interest rate could increase, and vice versa. Often it has been seen that for long-term loans like home loans, floating interest rate turns out to be cheaper than fixed rates. Mixed interest rate is fixed for a certain period of time after which it is changed to floating rate of interest. 

How is interest rate determined? 

As per the Reserve Banks of India’s mandate, all banks are required to link their interest rate to an external benchmark. Most of the banks have chosen the RBIs’ repo rate as their external benchmark. Accordingly, the interest rate is called the ‘Repo Rate Linked Lending Rate’ or RLLR. This means that any changes in the repo rate will automatically bring a corresponding change in the floating interest rate of bank loans.

However, there is more to it. Your floating rate of interest consists of two parts- the index and the spread. The index is based on the market rates like RLLR, however the spread is determined by the lender keeping into account the credit risk, profit margin, etc. While the spread remains the same throughout the tenure, your interest rate could fluctuate with the changes in the index. If the index rate increases so will your interest rate and vice versa.

So while one part of your interest rate is based on RLLR (index), the other part – spread – is determined based on your eligibility and creditworthiness. If the lender finds you to be a risky borrower, they can increase the spread rate and charge you a higher interest rate over and above the RLLR.

Factors that determine your home loan interest rate

  • Credit score – If you have a good credit score, you can get a home loan at a low interest rate. It is because a good credit score has a positive impact on your creditworthiness. As a result, the lender considers you to be a safe borrower who would not default in the loan repayment. On the other hand, if you have a low credit score, the lender can increase the spread rate considering the credit risk and offer you a higher rate of interest.
  • Income and job profile– The lender also considers your job profile and income before determining your interest rate. If you have a stable income with a good employment record, you are most likely to be charged a relatively lower interest rate. For example, lenders consider government employees as less risky borrowers owing to stable income and job and could charge them with lower interest rates.
  • Loan amount– It is essential to choose a loan amount smartly as it can influence the home loan interest rate. Making a sizeable down payment can help you secure lower home loan rates. Thus, you can consider saving up in order to make a significant down payment. Even if you do not get a significantly lower interest rate basis the down payment, your interest outgo over the loan tenure will certainly come down.
  • Bank’s benchmark ratio – As explained earlier, your interest rate is determined based on the external benchmark ratio, which happens to be the RBI’s repo rate in most cases. If the repo rate is high, you would have to pay a high interest rate.

Besides a interest rate, other factors too need to be considered before applying for a home loan. Other factors like processing fees, loan amount, tenure, pre-payment & pre-closure costs involved can also be crucial factors.However, do keep in mind that a specific lender will offer you a home loan interest rate based on your fulfillment of the eligibility criteria. So, make sure to understand every factor thoroughly and then, take a call basis your requirement.