One of the biggest changes recently pushed through by the Reserve Bank of India is the linkage of bank loan interest rates to external benchmarks like the repo rate. I’ve already written about this, but as part of this linkage, banks are allowed to tweak your loan interest rate on the basis of changes in your credit profile. If your credit profile worsens, you’ll need to pay a higher interest rate on your loan. If it’s strengthening, your reward will be a lower interest rate.
The background to these developments is that the RBI had mandated banks to implement external benchmarking by October 1. Government banks have shown a preference for the repo rate (the rate at which the RBI lends to commercial banks) while one foreign bank had already linked its loan to the three-month Treasury Bill yield. As several repo-linked loans have now been launched, it’s now getting clearer what it means for you as customers to take a repo-linked loan – and why it’s become important for you to be on top of your credit score game.
At this point, it should also be clarified that the new rules of engagement will apply to borrowers who’ve taken repo rate-linked loans. Borrowers on MCLR or base rate-linked loans will be exempt, and their loans will continue as per their agreements till the end of their tenure.
Good Credit Score = Low Interest Rate
The higher your credit score, the better for you. This held true even before external benchmarking. However, now it matters a great deal more.
What’s changed is that earlier your credit history was examined only at the time of your loan application, and it played its part in the computation of your loan rate.
But now, your loan rate will continue to shift in concurrence with your latest credit score through the tenure of the loan. So, for example, let’s say you had a high score of 800 during your loan application which was successful and got you the loan at the lowest rate. But during the tenure of the loan, you had the misfortune of making a late EMI payment, which lowered your credit score to 700. This would now impact your loan rate, and you’ll see an upward revision of your interest rate in line with your bank’s credit framework.
How Banks Will Compute Interest Rates
Various government banks have now advertised their loan rate break-ups and have also provided clarity on how the rates are computed with respect to the borrower’s credit profile. Bank of Baroda, for example, will reserve its lowest home loan rates for borrowers with credit scores between 760 and 900 – 8.1%. For borrowers with credit scores between 726 and 759, the rate is 8.35%, and for those with scores below 726, the rate is 9.1 per cent.
For the purpose of credit risk assessment, the bank will refer to the borrower’s credit scores computed by CIBIL. On the other hand, the State Bank of India reserves its lowest home loan rates for salaried, female borrowers on loans up to Rs. 30 lakh for borrowers in Risk Grade 1, 2 and 3. This grading is internal.
The lowest rate advertised by the bank is 8.20 per cent. However, for non-salaried borrowers, loans above Rs. 30 lakh, or for loan-to-value ratio exceeding 80 per cent, and for borrowers in Risk Grade 4, 5, and 6, a higher credit spread will be applied. SBI says that Risk Grade 4, 5, and 6 will have to pay a premium of 10 basis points on their rate.
How The Incentives & Disincentives Work
Borrowers will need to ensure timely payments through the tenures of all their borrowings. The downgrading of a borrower’s credit score will lead to a rise in a loan’s interest rate as mandated by the bank’s credit framework. Conversely, a rise in the borrower’s credit score will lead to a fall in his interest rate.
Therefore, there’s a clear incentive for borrowers to ensure timely repayments of all their loans. If you have concurrent borrowal accounts – for example, a home loan, a car loan, and credit card dues – ensure there are no delays on any of them.
Let’s say you have been punctual with your home and car loan EMIs, but if you miss a credit card payment, your credit score will fall, thus increasing the interest rates of your other loans.
Check Your Credit Scores Frequently
In the light of these developments, it becomes imperative to keep track of your credit score and take steps to manage it on a regular basis. Staying above the 750 mark will save you money—your EMIs may shrink or your loan tenures may reduce.
But falling below the mark will fatten up your EMIs or increase your tenures. If you don’t have recent borrowings and are not looking to borrow again in the immediate future, not knowing your credit score would be of little consequence. However, those with current borrowings and those looking to borrow again will have to track their credit scores regularly now. As a habit, they will need to check their scores at least once every quarter.
If a borrower is dealing with problematic debt (late payments, defaults, settlements etc.), it’s best to check the score once every month to stay updated. Tracking your credit score is also important from the point of view of spotting problems with your credit report. Wrongly reported data by your lender, for example, could needlessly bring down your score.
Good borrower behaviour is being rewarded like never before. Therefore, always know your credit score, and avoid debt-related problems.
The author is CEO, BankBazaar.com. The article has been published in collaboration with BankBazaar. Opinions expressed are those of the author.