How A Good Credit Score Can Lower Interest Rate On A Home Loan

A person's capacity to repay loans is demonstrated by their credit score, which is generated using data collected from lenders. All of the person's credit information is summarised by the three-digit number.

This score has the power to influence a lot of things in a person's life, from the interest rate payable on loans to the ability to negotiate with banks.

A credit score is generated based on the person's behaviour when using credit. It takes into account the person's repayment of loans and credit card payments, along with other similar dues. 

The system that generates this score starts with credit information companies. These companies receive monthly data about customers' credit usage and payment timing directly from banks.

In India, there are four main credit information companies, or CICs: CIBIL, Equifax, Experian, and High Mark Credit Information Services. The CIC receives these data, uses an algorithm to create a credit report and generate a score ranging from 300 to 900 points.

For a person who has already taken out loans or has credit cards, the best way to build their credit score is to always pay on time.

A common fallacy is that increasing the usage of credit is the way to improve the score, but Manish Jain, country managing director at Experian India, said, "Paying off the excess loans one has can also improve their credit score.”

Those who have not previously taken out any credit have a fresh start. There are a few recommended methods for building up your credit score, according to Parijat Garg, a credit scoring consultant: taking consumer loans, using a credit card, and taking gold loans, with the first two being more preferred.

“Availing loans, introducing some credit, and timely repayment will help build the credit score,” said Garg.

For example, a student fresh out of college starting their first job without any loans will have no credit information available about them.

“This can raise more questions from the bank when they want a loan, as they need to ensure that the person will be able to repay the loan on time,” added Garg.  

Introducing credit data can be as simple as taking out consumer loans or secured loans. This can also be done by taking credit cards that are backed by a fixed deposit.

Maintaining a good credit score unlocks benefits like preferential treatment from the credit industry in addition to lower interest rates.

A good credit score convinces the bank of your creditworthiness, which can lead to faster loan approvals. A higher score also gives the individual a higher eligibility to avail loans of larger size, as they have had the capacity to make repayments on time in the past.

An additional advantage that a credit score provides is the power to negotiate with the bank, according to Garg. This essentially means that you can make your case to the bank with the credit score backing your claim for lower interest rates or larger loans.

Looking for loans involves making multiple inquiries to banks to compare interest rates and try to figure out the best option available.

When you inquire with multiple banks, they shoot out inquiries to the credit bureau. There has always been confusion about whether these multiple queries coming in could reflect negatively on your credit score.

“We have adapted to evolving consumer behaviour. We understand that consumers are more aware and are going out to shop for a loan with the best interest rates and terms,” said Jain, confirming that this will not affect your credit score.

People sometimes make regular repayments and handle credit carefully, but mistakes made by the bank or credit bureau may cause the credit score to differ.

If you have spotted an error that is not because of defaulted payments, then you can report the issue to the bank and the credit bureau. The individual can both write to the bank and raise a dispute on the credit bureau’s website, according to Garg.

“If such a dispute is raised, then the issue is to be resolved by the responsible party within a month’s time as mandated by the Reserve Bank of India effective April,” said Garg.

Lenders use this score to assess the risk of granting an individual credit. The score can effectively help them determine if it is safe to lend to the individual.

"Loans will still be available for people with credit scores below 600, but it is difficult,” said Garg. The real difference shows in the interest rates charged. For example, in the case of home loans, people with credit scores over 750 would be able to avail loans with around 8.5% interest. On the other hand, people with credit scores less than 640 would have to pay 10–11% interest.

“This happens when frontline banks do not give them loans and they have to approach non-banking financial companies, which charge higher interest rates,” explained Garg.

Often, defaults occur because of events outside one's control. In some situations, emergencies pull away funds that had been set aside for loan repayments.

"A missed payment would have a negative impact, but it will recover gradually if you show increased behaviour of paying on time," said Jain.

The way forward is simple if you have defaulted on one payment, because all you are supposed to do is simply continue making payments on time.

“If you missed one payment, it would impact the score. However, maintaining discipline and paying all dues on time will help improve the score over a period. The scores factor in that it was a one-off or identify if you are a repeated defaulter. If you are a repeated defaulter, then there is an issue,” Jain said.

If you have defaulted on payments in the past, Garg recommends that the way out is by settling the past overdue and taking fresh credit or secure loans that will help improve your credit score. This fresh credit can be in the form of secure loans that are backed by a fixed deposit or gold loans.

Maintaining and improving your credit score will require regular repayments and careful credit management. Consistent effort can help you unlock benefits like lower interest rates, discounts, and much more.