27-Oct-2015 written by : Aman Kapoor
A mortgage is a debt instrument where immovable properties like buildings, lands, apartments etc. may be used as a guarantee in order to obtain a loan. Just like any other credit instrument the CIBIL score has a major impact on the outcome of loan request.
There is a common misconception that a mortgage loan shall get approved despite low or bad credit score (commonly known as CIBIL score). Before we get to know how the credit scores impact a mortgage loan application, let us first have a little understanding on what the credit score is all about.
Credit Bureaus collect data extended to them by various banks and lending institutions and apply complex logics to extend a credit score. Technically known as Credit Risk Score and expressed through a three digit number, score is reflective of the chances for one to default. In India the score ranges from 300 to 900 with 750 being considered as a benchmark for applicant being a low risk profile. Following are the bearing that this figure would have on the underwriters’ decision:
The loan application may out rightly reject in case of bad credit history. The banks are in lending business, where they make money through regular repayments of the loan EMIs. Any delay or non- payment leads to losses which is not an advisable situation to be in for any business. Any indication of potential loss on a loan will make the underwriter reject the application. Since score is an indicator for risk associated with the potential borrower, it plays a highly important role in the evaluation process.
LTV or the loan to value is the amount of loan getting disbursed against the value of the property being put up for mortgage. In case of a low score, the underwriter may still approve the loan, however to a far lower value against the prevailing market practices. A home loan can get approved for up to 90% of the property value and a Loan against Property can go up to 60%. The loan, in case of a low score may get pruned to as low as 30/35% of the property value.
Potential borrower’s risk profile also has a bearing on the rate of interest getting charged on the credit
facility. To clarify, as is the case in insurance where the premium is linked to amount of risk a person or
property is exposed to, similarly, the rate of interest also increases with decrease in credit risk score.
One needs to be cognizant that an increase of just 1% in the rate of interest can lead to substantial
increase in the interest getting paid. To put it in perspective, on a loan of Rs 50,00,000 a higher interest
of 1% shall result in outflow of a whooping amount of about Rs 10,00,000 in interest over a 20 year
term. This is a considerable amount and amounts to 1/5th of the original loan amount.
Since, the credit scores play a pivotal role in the processing of a mortgage loan, it is highly advisable that one checks upon his current score before applying for a loan. Understanding of credit health will lead to getting better loan terms from housing finance companies.