Quite surprisingly Lowest Interest Rate is a key criterion for almost all the new and existing borrowers. It can be safely concluded that 2 out of 3 borrowers avail a loan from Lowest Interest Rate provider typically market leaders in the segment. The rest are not eligible due to various reasons thus settle with other loan providers. From last so many years you might be reading that you can get a loan at lower interest rate if your credit score rating is good. This was a plain lie as none of the lenders was willing to offer differential interest rate just based on the Credit or CIBIL Score. In fact, one of the leading credit bureaus also mentioned the same on their portal. Though it is very common practice in the western world.
What is the Incentive for a Borrower to maintain Good Credit Score?
Recently i had an eye-opening discussion during credit consultation session with one of the Govt Employees from Nashik. His credit score was 725. Total 12 accounts were reported in his credit report. The existing status was 2 active, 6 closed, and 2 settled accounts. The settlement was reported against credit card and personal loan. I suggested him to go for CIBIL Masking and make a payment of Rs 1,29,000 against settled accounts. He simply refused. He told me why he should pay? Till date, he has not faced any problem in availing loans/credit card. What is the incentive for him to close settled accounts? In other words, it is okay to default till you are easily getting loan/credit.
To summarize, the relevance of a credit score is limited only to loan/credit approval. The only and sole concern of the borrower is to avail a loan. For example, if a Bank A is providing Car Loan at 9.75%. In this case, there is NO DIFFERENCE between Borrower A with Credit Score of 870 and Borrower B with Credit Score of 725. You can also conclude that a borrower always has a certain degree of leverage to default on loan/dues. But the rules of the game changed and such borrowers will be penalized by way of higher interest rate. Though the Borrower B may avail the loan facility but by paying higher interest rate compared to Borrower A.
The mirage of past is now the reality of the present. The Bank of Baroda became the first bank to offer home loans linked to the credit score of the individual. In other words, the borrower will be incentivized for maintaining a HIGH credit score.
For example, the current MCLR of Bank of Baroda is 8.35%. A potential borrower with a credit score of 760 or more will be able to avail the home loan at lowest interest rate i.e. 8.35%. In other words, the markup or spread on the MCLR is 0%. The spread for a borrower with a credit score of 725 to 759 will be 0.5%. Therefore net interest rate will be 8.85%. Anyone with a credit score of below 724 will have to pay 9.35% interest rate i.e. spread of 1% over MCLR. A difference of 36 points in credit score can increase your home loan interest rate by good 1%. Borrowers with NO credit history will be charged 8.85%.
Some of you might be wondering what’s the big deal in 1% difference in the interest rate or lowest interest rate. Let’s check the absolute impact. Assuming Borrower A availed home loan of 50 lacs at 9.35% with a credit score of 720. On the other hand, Borrower B with a credit score of 770 availed a 50 lacs home loan at 8.35%. In this case home loan amount is same but there is a difference of 1% in interest rate. Total interest outflow of Borrower A will be approx 61.22 Lacs and that of Borrower B will be approx 43.66 Lacs considering the EMI is same. Secondly, Home Loan of a Borrower B will be closed in 204 months instead of 240 months for Borrower A.
In short, savings of 1% interest rate can help you save approx 17.56 Lacs and Home Loan Tenure will reduce by approx 3 years. I am confident that this practice of offering lowest interest rate to borrowers with high CIBIL Score will be adopted by all the banks and for all types of loan. Therefore by maintaining high credit score you can avail loan at lowest interest rate. You can save huge amount towards interest outflow.
Lowest Interest Rate – Unanswered Question
1. Can existing borrowers shift to lowest interest rate based on Credit Score?
In all probability, the answer is NO. I know that banks will give the standard answer that Risk Assessment is done at the time of availing loan. On the other hand, in my opinion, banks should check Credit Score of existing borrowers annually and adjust loan interest rate accordingly. It will help to control NPA’s of the bank. Bank will come to know about all the borrowers whose credit score dropped in last one year. It will point to a bad credit behavior in last one year and may be an early sign of default.
Continuing with the same example. If the CIBIL score of a Borrower B decrease from 770 to 750 then the bank can increase the spread from 0% to 0.5% and the interest rate will increase from 8.35% to 8.85%. In worst cases, the bank may tell borrower to close the home loan to avoid potential NPA’s.
Similarly, in the case of Borrower A, if his CIBIL Score increase from 720 to 740 then his interest rate can be decreased from 9.35% to 8.85% or he may be offered lowest interest rate in case he cross the threshold of 760. This practice will overall help the financial sector to reduce NPA’s and desist borrowers to delay/default on loan/credit facility. Therefore, the borrower will be always on the edge and forced to adopt good credit practices to keep interest rate low. Otherwise, he/she will be penalized with higher interest rate.
2. I have poor credit score i.e. 571. I am willing to pay high interest rate. Can i avail loan?
Again in all probability, the answer is NO. This is one of the grudges of potential borrowers with poor credit score. The most common excuse for loan rejection is poor credit score. But now loan interest rate is linked to credit score then it will be reasonable for borrowers with poor credit score to expect loan approval obviously at higher interest rate. For example, in the communication from Bank of Baroda, it is mentioned that if your credit score is below 724 then the home loan is available at 9.35%. Therefore, can i assume that a potential borrower with a credit score of 571 will get a home loan? I hope so but i am not convinced.
It is more prudent on behalf of banks to publish minimum credit score for loan approval. Though the unwritten rule says min credit score of 700 is required to avail the loan. Therefore, my financial wisdom says that the borrower with a score of less than 700 will not be able to avail loan at all. At the same time, borrowers with a score of 760 or more will enjoy the fruits of lowest interest rate.
Words of Wisdom:
There is a famous quote that “The Winners take it all”. The same applies to a credit score. The banks are reluctant to lend to borrowers with poor credit score. But they are alluring the borrowers with good credit score by offering lowest interest rate. Earlier the key concern of a borrower was only loan approval. Now it will change to loan approval at the lowest interest rate as it will result in savings. After all, Indians are highly sensitive to interest rates be it savings/investment or availing loan/credit facility.
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