- Date : 08/04/2021
- Read: 9 mins
If the lending bank thinks you have too many debts to handle or they are being mismanaged, your home loan application may get rejected.
The 2009 Hollywood horror flick Drag Me to Hell should carry a lesson for home loan borrowers anywhere, including India. Sounds a bit of a stretch? Not really.
On one level, the film is about a loan officer at a California bank who is possessed by an evil spirit after a gypsy woman puts a curse on her over a mortgage foreclosure. On another, the movie shows the result of not clearing a home loan – the loss of a permanent shelter. (It was the ‘shame’ of becoming homeless that drove the gypsy woman to cast her evil spell on the loan officer.)
The movie, released as it was amid the 2008 subprime crisis, was a hit. The portrayal of an evil spirit appealed to young viewers, while a horror of another kind – foreclosure – struck a chord with adults; after all, about 10 million American debtors lost their homes between 2008 and 2012.
The debt threat
For Indian home loan borrowers, the lesson here (minus the occult angle) is this: lending banks can be very strict with defaulters; to the point where they can repossess your new home if you default on your repayment. So, unless you know how to cast evil spells like our fictional gypsy, be prepared for a close scrutiny of your finances if you are planning to apply for a home loan.
The lending bank not only checks who your employer is, your employment and income status, as well as your solvency to decide your eligibility, it also checks what other debts you may have. This means any loan(s) you may have taken earlier will have a bearing on your home loan approval. If the loan officer thinks you have too many debts to handle or they are being mismanaged, your home loan application may get rejected.
Banks try to gauge your solvency from your debt-to-income (DTI) ratio. This is a measure of your income that’s being used for debt repayment. A low ratio reflects your ability to pay back a debt (your creditworthiness), while a high ratio points to potential inability to pay new EMIs.
Some Indian NBFCs consider a DTI of 21%-35% as ‘good’. They feel this shows the borrower to be in a comfortable financial condition. For most lending banks, a DTI of 30% is the threshold limit for sanctioning loans, including home loans.
A favourable DTI is important as it affects your credit score and credit rating, which is based on your past debts and repayment history. Banks give a lot of weight to your credit score if you wish to borrow money. This score is numerically represented by a three-digit number in the 300-900 range (on the score sheet of credit rating agency CIBIL), and a score above 750 is considered good.
If you have a high credit score, banks are likely to approve your application quickly and readily, and so you should endeavour to be as near the 900 mark as possible. Moreover, banks can also offer lower interest rates to customers with high credit score. Conversely, a score in the 300-549 range shows you have been tardy in squaring debts and loan EMIs. It is, therefore, a bad score, and can sink your home loan application.
As you can see, a credit score can either boost or scuttle your efforts to get a home loan. Given this, it is advisable to know of the loans and debts that that impact your credit history. Below is a list of such debts; if you have any of these, your home loan officer is bound to ferret it out before taking a call on approving your application.
Loans and debts
1. Credit card dues
Credit card dues are the most common form of debt going around, as people use a card for almost anything these days – from groceries to white goods, and restaurant meals to air tickets. However, such dues have a direct impact on home loan approvals.
If you use a credit card, try to clear as much of the dues as possible before applying for a home loan. This is because a huge outstanding can affect your credit score negatively and bring down your creditworthiness; it will not matter if you pay your minimum monthly dues promptly.
At the same time, lenders do not merely look at credit card balances and repayment histories; what is also important to them is the credit limit. If you have multiple credit cards with high credit limits, you will be seen as someone who may use more cards more often to borrow more money. Basically, lenders see a high credit limit as future debt.
In other words, you will be seen as a high-risk borrower, which would affect your home loan approval chances. In this case, it is a good idea to think about closing some card accounts or lowering card limits. But if you can demonstrate that you are capable of using credit cards responsibly, you will be seen as a reliable, low-risk borrower. This will help improve your credit rating.
2. Personal loan
Another loan category that can impact your home loan application is the personal loan. This is actually not designed for a specific purpose, unlike an auto, home, or education loan, and can be used for anything.
Usually, people take personal loans to meet financial exigencies, like an unexpected medical expense. However, they also use it to clear large and high interest debts like credit card dues, because personal loans generally carry lower interest rates than credit cards. This can prove useful in building your credit score, provided you use personal loans right.
Let’s take the case of paying off credit card dues with a personal loan. Credit card dues are what are called ‘revolving credit’. There’s no fixed amount due; it depends on how much you spend every month from your available credit limit. This spending indicates your ‘credit utilisation rate/ratio’; a low rate (say 30%) indicates good management of credit and not overspending.
Lenders like it if you have a low credit utilisation rate. The problem is, there is always the danger of this rate spiralling. On the other hand, a personal loan is an instalment loan that does not involve credit utilisation rate, and is easier to manage.
Therefore, using a personal loan to pay off a revolving debt such as credit card dues will help you improve your credit score, which in turn can help you secure a home loan more easily. You can also increase your credit score by clearing personal loan dues in full and on time every month, thereby establishing a positive payment history.
However, if you misuse a personal loan while paying off credit card dues, you will find yourself getting deeper into debt; it is important you change your lifestyle habits that landed you with high-interest debt in the first place.
3. Car loan
Credit card dues are impulsive debts, personal loans are mostly emergency debts, but two loans that are usually planned are car loans and home loans; these are for much-cherished purchases. One can also impact the other.
In other words, if you have a car loan, its EMI size and how you manage the instalments will influence your home loan approval. This is because the debt-to-income ratio comes into play with an auto loan. If payments are on schedule, your credit score will go up, but if you miss a few EMIs, it could push your DTI above the limit of 40%, in which case you may not qualify for a home loan.
Timely payments of your car loan EMIs will also raise your credit score. In fact, if your score is below par, you can try to manage your auto loan efficiently to make it work in your favour by making repayments on time; this will help your home loan application find a stronger footing.
4. Student loan
Like all other types of debt, student loans too will have an impact on your home loan approval process. This is because when calculating your DTI, the lending bank will add your student loan – if any – along with the other debt payments you owe on a monthly basis.
But in India, the education loan segment has witnessed defaults rising in recent times. According to media reports, the non-performing asset (NPA) component in this segment leapt to 8.97% by the end of March 2018, compared to 7.29% in March 2016, and 5.7% in March 2015.
One reason for this is India’s rising unemployment. Analysts quoted in these media reports said there were fewer jobs for students who have completed courses after paying high fees, often with loans; and this was leading to defaults.
Be warned, if you have a student loan, banks will be extra wary of your solvency. It is especially important that you make timely repayments of student loan EMIs, since missing payments could lower your credit score at a time when lenders are carefully considering this metric.
5. Shared loan
It is entirely possible that you have jointly taken a loan with someone else – maybe a sibling or some other relative or friend. This makes you a co-borrower, and liable for the debt. What this means is that if the other person is unable to repay their share of the repayment amount, you are responsible for the outstanding balance.
Moreover, bankers know that joint borrowers, even if they are siblings, can always fall out. This can lead to one of the borrowers refusing to repay their share of the loan, which will make the co-borrower open to legal action over repayment default. Lenders of home loans will likely not entertain applications from such co-borrowers, as their ability to make EMI payments will be suspect.
Before you start checking out residential properties to shortlist a new home or begin loan shopping, it is advisable to take stock of your finances. This includes being up-to-date on your loans and acknowledging them. Also make sure to evaluate different loan repayment plans and explore ways to make your payments more manageable.
If you have a healthy credit history, there should not be anything to worry about. If not, start making timely payments to improve your credit score. Ultimately, do not give the lender the impression that you are not a responsible borrower. Read this TomorrowMakers’ home buying guide for India [PART – I].
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.