Buying a home? Know your loan eligibility

The festive season is considered an auspicious time to buy a house. But lenders including State Bank of India, ICICI Bank, Punjab National Bank and HDFC have raised lending rates by 5-10 basis points earlier this month. And a rise in interest rates means higher equated monthly installments (EMI), which impacts loan eligibility and affordability.

In this background, it becomes even more critical that borrowers get the best possible rates. Let us look at what steps one can take to improve one's home loan eligibility.

Criteria affecting eligibility

Income is the first and foremost factor that affects a home loan borrowers' eligibility. The lender will sanction the loan amount based on your income and will ensure that the repayment does not exceed a certain percentage of your take-home pay.

Besides income, lenders also look at factors such as property value, borrowers' credit history and score, existing loans, etc. "Other than loan applicant's income, lenders also factor in credit score, existing EMIs, age, job profile, employer's profile, location and title of his property, etc, while determining eligibility. An adverse situation with respect to any of these factors may lead to rejection of the home loan application," said Ratan Chaudhary, associate director and business head - home loan, Paisabazaar.com.

According to Navin Chandani, chief business development officer, BankBazaar.com, a borrower's credit history and score have a huge role in determining the eligibility of a borrower. "While the income shows the borrowers' earning capacity, the credit score and history reveals their repayment capacity and how well they do this,'' he said.

Banks also calculate a borrower's eligibility on the basis of property value, wherein they limit the loan value to a certain percentage of property value, said Gaurav Gupta, co-founder and CEO, MyLoanCare.in. This ratio is known as loan to value (LTV) and ranges between 75-90% of the property value, depending on the loan amount. The maximum LTVs have been fixed by Reserve bank of India for loans of different amounts. For arriving at the property value, most banks include property cost based on prevailing market rates, development charges, preferred location charges and the cost of parking.

"The way it works is that banks estimate a borrower's eligibility based on his income, as well as based on the property value and limit the loan amount to the lower of the two,'' Gupta said.

Can you increase your eligibility?

Given that all lenders consider credit score while approving a home loan, you must first check your credit report at least six months prior to submitting the loan application. "This will give you time to take corrective steps for improving the credit score, if required, and also help to detect errors and take necessary action. A corrected credit report would automatically improve the credit score,'' said Chaudhary.

Having no credit score is bad because it doesn't tell the banks anything about your money management skills. There is no way the bank can evaluate your financial behaviour, pointed out Chandani.

Similarly, lenders prefer to lend to those having a fixed obligation to income ratio (FOIR) of less than 50%, Chaudhary added. Fixed obligation includes existing EMIs, insurance premiums and other mandatory monthly expenses. "If your monthly income comes in the way of qualifying for a home loan, you can add your working spouse or children to increase loan eligibility. You can also opt for a longer tenure and/or lower LTV ratio to reduce EMI and increase home loan eligibility. Adding co-applicant(s) would also improve your eligibility in case your age or credit score is insufficient for qualifying for a home loan,'' he said.

Borrowers can also increase their eligibility for higher loan amounts by closing existing loans. Higher income also enhances borrower's eligibility and hence, if the borrower is earning income through other sources such as rent, then he/she should mention such income details in the application form with detailed proofs, said Gupta.

Do a proper research of the existing home loans in the market. This is important because a higher interest rate would lead to higher EMI and this could result in a lower loan amount.

It is also important to repay existing debts on time to improve credit score, as well as increase your eligibility. If you have no credit history, you can invest in building a credit score by taking a credit card, a small value personal loan or a car loan. But give yourself a year or so for this exercise.

How to deal with rising interest rates?

If your lender has hiked rates, existing home loan borrowers with long residual tenures should prefer home loan balance transfer option over making home loan prepayments, said Chaudhary. "Home loan balance transfer allows you to transfer your existing home loan to another lender at a lower interest rate and thereby reduce your interest cost. While doing so may incur additional cost, you wouldn't be required to sacrifice your liquidity or existing investments as in the case of home loan prepayments."

Those having shorter residual loan tenures, say less than three years, can consider making prepayment, as the cost and effort involved in transferring home loan may not justify the savings made from the balance transfer.

Banks typically limit the loan amount to a value, where the resulting EMI including all other existing EMIs of the borrower does not exceed 60% of his net monthly income, said Gupta.

Let's take an example where a borrower wants a loan of Rs 30 lakh for a tenure of 30 years, at an interest rate of 8.65%. The borrower has a net income of Rs 50,000 per month and an existing auto loan EMI of Rs 6,000. The total EMI in this case will be 23,387, which together with existing EMI of Rs 6,000 is less than Rs 30,000 or 60% of his monthly income. At this calculation, the borrower is eligible for a loan amount of Rs 30 lakh. However, if the interest rate increases by 100 bps to 9.65%, then the EMI will also increase for the same loan amount. The revised EMI will be Rs 25,555 for 30 years, which means total EMIs of more than Rs 30,000 or 60% of the borrower's monthly income. The borrower is no longer eligible for a 30 lakh loan and his affordability stands reduced.

Banks typically give two options to borrowers, wherein the default option is to increase the loan tenure keeping the EMI unchanged or to increase the EMI without changing the loan tenure. The right choice for a borrower is a function of his affordability.

"If you have a high income, you should opt for a higher EMI to lower your total interest outgo. You can also consider prepaying a certain portion of your loan amount to reduce the interest liability. A longer tenure should be opted for only if the borrower is not comfortable servicing a higher EMI at his current income,'' Gupta said.

DO THE CALCULATION

• 75-90% – Amount of the property value that banks offer as loan amount
   
• 50% – The fixed obligation to income ration that lenders prefer to lend to
   
• 5-20 bps – Increase in home loan rates since October 1