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Importance of a good credit score for a home loan

A credit score chart. It shows a speedometer with a needle pointing to a score

Why credit score is important for home loans and how to improve it

No matter what kind of loan you apply for, lenders need to ensure that you have the capacity to repay it. To confirm your repayment capacity, they ask you to submit a lot of documents – from your salary slips and bank statements to your income tax returns -- and also consider your credit score. A credit score is a three-figure number that helps lenders understand how often you borrow sums on credit and whether or not you are repaying the loans regularly. Credit scores are especially important when you apply for a home loan. Here’s why lenders ask to see your credit score to buy a house and why it is important.

Importance of credit score to get a home loan approved

The following are the main reasons why banks consider your credit scores

  1. It helps the lender understand your credit behaviour
    From the different types of loans you have taken in the past to the ones you are repaying currently (while applying for the loan), lenders can see how you handle credit. Credit scores are calculated not just from the loans you have taken, but from how you have used your credit cards. Lenders can get an insight into how much you use your credit card, your credit utilisation ratio and whether you have repaid both your credit card bills and previous and current loans on time, without defaulting. As such, the credit score gives your lender a detailed look into how you manage all kinds of credit.
  2. It helps the lender see if you have the capacity to repay the loan
    When you apply for a home loan, you need to prove your eligibility. One of the best ways to check if you are eligible is through your income sources. Lenders require you to comply with the minimum income requirement. If you are not drawing a certain monthly income, you may not be eligible for the loan. Your income and credit scores help lenders decide if you can indeed repay the loan on time, which is why lenders consider your credit score for house loan.
  3. It helps lenders see if you have any other ongoing loans
    Borrowers who have ongoing loans while they apply for another loan are considered rather risky by lenders. A new loan means an added financial responsibility while your income remains the same. Through your credit score, the lender calculates if you can repay a high-value home loan. They check your loan to value ratio -- i.e. the monthly income drawn and the amount of money spent in repaying your credit card bills and your other loan EMIs. If the loan to value ratio exceeds 60%, lenders can consider you ineligible for the loan.

How to improve credit scores

The credit score needed for home loan is a minimum of 750 points out of a possible 900. Here’s how you can improve the score

  1. Ensure you don’t have any outstanding debts
    Whether it’s any other loan or your latest credit card bill, ensure you have paid them all off before you apply for the home loan. Not having any outstanding debt – just the regular credit card cycle (which shows that you are taking those mini loans but also repaying them month after month) -- can help you get your home loan passed.
  2. Don’t utilise your entire credit limit
    Another way to improve your credit score for home loan is to ensure you never use up your entire credit limit. Lenders prefer to sanction loans of borrowers who never utilise more than 30% of their credit limit. As such, you must limit your credit utilisation ratio to this 30%. This simply means that if your credit limit is Rs.100,000, you should only spend Rs.30,000 on your credit card each month.
  3. Repay your debts without defaulting
    A sure-shot way to improve your credit score is to repay your debts without ever defaulting. Ensure you never miss your EMI payments and avoid paying them late. Also, try not to just pay the minimum amount necessary for your credit card debts and pay off the entire amount before the new credit cycle begins. If the lender sees you defaulting on any debt, your loan could be rejected.
    Final Word: The credit score required for home loan is 750 and above. Most lenders, especially banks, are quite rigid and only sanction loans to borrowers who can achieve this minimum score. Housing finance companies, on the other hand, are more lenient with regard to credit scores and may sanction loans to borrowers with credit score ranging between 600 and 750. But while you can get the loan, the interest rate levied on it is generally high.

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