Help and Advice

How Does Your Credit Score Determine Your EMI?

How Does Your Credit Score Determine Your EMI?

The Relationship Between Score and Your EMI Explained

Sam works in an IT company in Bangalore. He is planning to buy a home and hence is on the search for a home loan at reasonable rates. Sam also works in the same company and a few months ago had bought a new flat on home loan. Naturally, John speaks to him and realizes that there isn’t much difference in the salary that they are drawing. The EMI paid by John is very reasonable and Sam didn’t have to think twice before approaching the same bank for a home loan application for the same amount. The bank representative collected the necessary details and said he will call back with a quote.

Two days later, Sam did receive a call from him, but the interest charged was much higher than what was offered to John. It took quite a lot of convincing from the bank official before John realized that his salary isn’t the only factor that determines his EMI. The crucial difference here was that while Sam had a healthy credit score of 795, John’s was merely 420, courtesy some reckless credit card spending habits.

And what does this ultimately mean?

So what do we take from this? While most of us is already aware that credit score plays a significant role in determining whether our loan application will go through or not, very few are aware that many banks these days fix the interest rate on the loan based on the credit score. However, this is completely bank-specific for now. The day is not too far away when most banks will be using the credit score to determine the EMI and interest rate on loans.

Bank of Baroda has already jumped into this bandwagon and others are expected to follow suit. Bank of Baroda has launched a home loan plan where the EMI is linked directly to the credit score of the individual. Infact, it makes a lot of sense considering that credit scores these days have become quite comprehensive and depict a detailed picture of one’s credit history. Let us look at how the interest rates will vary with your credit score. To understand the impact better, let us consider what Bank of Baroda is offering.

  • For individuals with CIBIL score above 760, home loan will be offered at the base interest rate of 8.35% p.a
  • If your credit score is between 725 and 759, the interest rate offered is 8.85%.
  • For individuals with credit score below 724, the rate is as high as 9.35% p.a
There is a Line

There is a flat difference of 1% in interest rate for individuals with a good and bad credit score. Although 1% may seem a negligible figure, in the world of home loans, this difference can easily go in to lakhs.  To put this into perspective, for a loan of Rs 50 lakhs for 20 years, the difference in interest paid is Rs 7.68 lakhs, which is quite a significant figure.

However, it should be kept in mind that CIBIL is just one of many parameters that determine your eligibility for a loan. There have also been instances where loan applications from individuals with strong credit scores have been turned down due to various reasons.

What should you do?

It goes without saying that before applying for a loan, one should check their credit score to have a realistic shot at seeing the application through. Further, checking the credit score also lets you calculate the kind of EMI you will be paying on the loan. If the credit score is too low, you may want to put it on hold for the moment and devise plans to improve the score before you submit the application. Also, checking the credit score also allows you to look for discrepancies and correct them in a timely manner. If you are someone who does not have any credit history to speak of, you may want to apply for a credit card and build a history first before applying for a loan.

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