What is Home Loan Interest Rate, and How is it Calculated?

When you avail of a home loan to purchase your dream house, you must repay the principal amount, i.e., the money you borrow, along with the interest rate levied by the lender. If you are wondering what the home loan interest rate is? You can consider it as the cost of loan or the cost of borrowing.

You must repay the interest over the tenure of the loan along with the principal amount that you borrowed in smaller instalments through EMIs or Equated Monthly Instalments. When looking for the best home loan offer, you must consider the interest rate on home loan levied by the lender as a critical factor before making a financial decision.

The rate of interest on home loans has a direct impact on the EMI amount and affordability. Higher the interest rate, higher will be your EMI, and the overall amount you repay.

 

How is the interest rate on home loans calculated?

The home loan interest varies from one lender to another. While the lenders follow the RBI (Reserve Bank of India) guidelines to determine the home loan interest rate, they also consider the following factors:

• Repo Rate

One of the most important factors that lenders consider while determining the home loan interest rate is the benchmark rate set by the Reserve Bank of India. This benchmark rate is called the REPO rate, and financial institutions, be they banks or NBFCs (non banking financial companies), charge an additional rate on the base rate to arrive at the interest rate on a home loan.

Although the lenders can choose the external benchmark rate for computing the rate of interest on home loans, most financial organisations in India use the REPO rate as the benchmark.

• Credit Score

When you apply for a home loan, the lender will definitely review your credit score provided by reputed credit rating agencies like CIBIL. This gives the lending organisation a fair idea about your creditworthiness and your past credit history. This also gives them the chance to assess whether you are a high-risk borrower or not.

The higher your credit score, and closer to 900, the better your chances of getting the loan application sanctioned without any hassles. In addition, if you have repaid your dues on time in the past, the lender may offer a lower interest rate on home loan

• Type of interest rate

Typically, in India, the home loan interest rates are of two types – fixed interest rate and floating rate. As the name says, in a fixed interest rate home loan, the interest rate remains unchanged throughout the loan tenure. Whereas, in floating interest rate loans, the interest rate changes due to the external market conditions.

So, if you take a home loan on a floating interest rate, your EMIs will remain the same, but the amount of interest deducted may change, and therefore, it involves an element of risk. But it is also true that financial experts recommend taking floating rate home loans as the interest rate for such loans tends to be a few points lower than the fixed rate loans.

• Loan duration

The loan tenure or the period you choose to repay the amount has a direct impact on the EMI and the interest rate. Typically, if you choose a longer tenure, the interest rate tends to be lower compared to short-term loans. However, this may not always be the case as some lenders keep the interest rate constant irrespective of the tenure you choose.

Also, if you choose a shorter tenure, your EMI would be high but at the same time your overall interest payment would be lesser.

While most lenders in India primarily consider the above-mentioned factors to calculate the rate of interest on home loan, some lenders may also take into account other things like your existing relationship with the lender. For example, if you already have an on-going loan with the lender and you have made all your EMI payments on time, the lender may offer you the loan at discounted interest rate.

 

Conclusion

The interest rate is a critical factor that you must consider when taking out a home loan. Also, apart from getting quotes from different lenders, it is also advisable to use the home loan EMI calculator and know what is the interest rate for a home loan and the corresponding EMI at that rate. This will help you make an informed borrowing decision.