Decoding Interest Rates: Guide to Home Loans ROI in India
Every Indian grows up with a dream to have their own “Makaan” - build their own home. However, with rapid urbanisation and the country’s economic growth trajectory, owning a home is getting harder and harder. This is where home loans play a critical role as they empower people to realise this dream (see The future of home finance in India) , but navigating the financial intricacies, especially understanding the interest rate or ROI (Return on Investment), can be daunting for most.
This blog by Ambak aims to decode the ROI equation and equip you to make informed decisions regarding your home loan. Let’s dig-in!
What is Rate of Interest?
The rate of interest (ROI) refers to the cost of borrowing money. It's the percentage charged by the lender (bank or NBFC) for lending you a specific amount (principal) for a certain period (loan tenure). In simpler terms, it's the rent you pay for using the lender’s money.
ROI Equation Breakdown:
Imagine you borrow ₹10 lakhs for 20 years at 8% ROI. Let's dissect how the interest is calculated:
Principal (P): ₹10 lakhs (the amount you borrow)
Interest Rate (R): 8% per annum (the cost of borrowing)
Loan Tenure (N): 20 years (the duration of the loan)
The most common formula used is the EMI (Equated Monthly Instalment) formula (Read more on EMI calculations here)
EMI = [P x R x (1+R)^N] / [(1+R)^N - 1]
Plugging in the values:
EMI = [10,00,000 x 0.08 x (1+0.08)^20] / [(1+0.08)^20 - 1]
EMI ≈ ₹8,010
This translates to a total interest paid of:
Total Interest = (EMI x N) - P
Total Interest = (₹8,010 x 20 x 12) - ₹10,00,000
Total Interest ≈ ₹21,62,880
Therefore, over 20 years, you'll repay a total of ₹31,62,880, with ₹21,62,880 being the interest component.
How do Banks and NBFCs set the ROI:
There are various factors that influence ROI for borrowers:
Credit Score:
Credit scores assess the creditworthiness, potential for repayment, and intent for repayment. A clean credit history which has timely payments and manageable debt indicates that the borrowers is financially responsible and a comparatively low-risk profile.
Impact: A higher credit score (750+) signifies responsible credit behavior, This translates to lower interest rates as they perceive you as a reliable borrower.
Loan Amount and Tenure:
While counterintuitive, lenders view larger loans as a sign of commitment and longer tenures spread the risk over a longer period. Hence longer tenures lead to potentially slightly better rates. However, keep in mind that the total interest paid will still be higher due to the larger principal amount.
Impact: Larger loan amounts and longer tenures may qualify for slightly lower interest rates.
Margin of Down Payment:
By putting down a larger chunk of your own money, borrowers can demonstrate financial stability and reduce the lender's exposure to risk. This incentivizes the latter to offer more competitive rates as they perceive the loan as less risky.
Impact: A bigger down payment on your home purchase can significantly reduce the loan amount and risk for the lender, leading to potentially lower interest rates for the borrower.
Income and Employment Stability:
Consistent income and secure employment are considered strong proxies for borrower’s ability to make regular loan payments. Lenders consider these factors while determining your loan eligibility and the risk-level of the borrower’s profile and may offer better rates to individuals with demonstrably stable financial situations.
Impact: Stable income and consistent employment history directly influence your interest rate eligibility.
Property Type and Location:
Lenders analyze property types and locations to assess resale value and potential risks. For example, a commercial property might carry higher risk compared to a residential one, leading to a slightly higher interest rate. Similarly, properties in desirable locations with high resale value might attract lower rates due to lower perceived risk.
Impact: Certain property types (commercial vs. residential) or locations (rural vs. urban) might carry varying risk levels, impacting the ROI.
Processing Fees and Other Charges:
While not a part of ROI calculations directly, consider these additional charges as they impact your total loan payout. Opting for lenders with lower processing fees and flexible prepayment options can indirectly improve your overall ROI.
Impact: Processing fees, prepayment penalties, and other charges indirectly affect your overall borrowing cost.
Reserve Bank of India's (RBI) in determining interest rates:
Interest rates set by lenders is heavily influenced by certain macro parameters and regulatory norms set by the Reserved Bank of India. The key parameters that determine the lending ability and criteria for Banks and NBFCs include:
Repo Rate: This is the rate at which RBI lends money to banks. Banks use this as a benchmark for setting their lending rates.
Cash Reserve Ratio (CRR): The percentage of deposits banks must maintain with RBI, impacting their liquidity and influencing loan pricing.
Statutory Liquidity Ratio (SLR):The portion of deposits banks must invest in government securities, affecting their available funds for lending and potentially influencing ROI.
Know more about RBI guidelines and regulations here!
Other factors influencing ROI:
There are other additional factors can influence how high or low the ROI turns out to be:
Market Conditions: During economic downturns, banks might offer lower rates to attract borrowers.
Bank/NBFC Competition: Intense competition can lead to better rates for borrowers.
Negotiation: Don't shy away from negotiating for a better ROI based on your financial profile and creditworthiness.
Tips to Improve Your ROI:
Given everything we understood of ROI and its components, we will discuss a few key points that can can help you secure lower Interest rates:
Maintain a Good Credit Score: Aim for a score above 750 for attractive rates.
Increase Down Payment: A larger down payment reduces the loan amount and risk, potentially lowering the ROI.
Shop Around and Compare Rates: Don't settle for the first loan offer you get. Instead, compare rates from different lenders as they have their own USPs that can benefit your profile.
Negotiate Effectively: Highlight your strengths and negotiate for a better rate.
Explore Pre-approved Offers: Having pre-approved offers from multiple lenders gives you leverage during negotiation.
Choose the Right Loan Type: Fixed-rate loans offer stability, while floating-rate loans might benefit from potential rate reductions.
Remember, ROI is just one piece of the puzzle. Consider factors like processing fees, prepayment penalties, and overall customer service before making your decision.
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