Low credit score? Here's how to still get that home loan and fix your finances.
A low credit score doesn't necessarily preclude access to financing, thanks to progressive financial instruments such as mortgage-guarantee-backed home loans. But these are no substitute for sound credit behaviour.
A credit score is a three-digit number from 300 to 900 that represents a borrower's creditworthiness. It is calculated using algorithms that evaluate various aspects of an individual’s credit behaviour, including but not limited to repayment history, credit utilisation ratio (the percentage of your total available revolving credit that you are currently using), number of credit accounts, age of credit lines, and frequency of credit inquiries.
A good credit score not only facilitates access to credit but also serves as a comprehensive indicator of an individual's financial behaviour and reliability, effectively functioning as a financial resume.
Why your credit score matters
A good credit score significantly influences several parameters of a home loan application, including the rate of interest, loan-to-value (LTV), and tenure eligibility. Given that home loans are typically large and have long tenures, a strong credit score gives borrowers to access loans at more favourable terms, thereby reducing their monthly payments.
Conversely, a weak credit score can severely impair an individual’s ability to secure a home loan. It indicates elevated credit risk, prompting financial institutions to apply more stringent underwriting norms. These may include requirements for additional documentation, collateral details, income proofs, and mandates for co-applicants or guarantors. Such measures serve to offset the perceived risk associated with a non-satisfactory repayment history, as indicated by a low credit score.
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Many financial institutions (FIs) apply credit score thresholds to loan applications. This helps them filter out borrowers who do not align with their risk appetite or strategic objectives. For example, while a credit score above 750 is considered strong, institutions may set operational thresholds at 600 or 650 when processing home loan applications.
Additionally, credit scores are often used to determine pricing. Borrowers with higher scores may receive interest rate discounts, while those with lower scores may be charged a premium to compensate for the higher risk.
FIs also conduct periodic credit bureau scrubs to refresh borrowers' credit scores. This ongoing monitoring enables them assess portfolio quality and detect early signs of stress. In cases where a borrower’s credit score deteriorates, institutions may take corrective action such as increasing the interest rate or restricting further credit exposure.
How to improve your credit score
Improving one’s credit score is crucial for accessing loans at competitive interest rates and on favourable terms. You can take the following steps to enhance your credit profile:
Maintain a low credit utilisation ratio: A lower ratio indicates prudent credit management and positively impacts your score.
Clear outstanding dues: If your credit report reflects a “settled" or “written off" status, aim to repay the full outstanding amount and request the lender to update the status to “closed" in the credit bureau records.
Limit new credit inquiries: Each credit application results in a hard inquiry, which can reduce your score. Several applications over a short period may be viewed as a sign of credit-hungry behaviour.
Monitor your credit report regularly and maintain a balanced credit mix: A healthy blend of secured credit (such as home or auto loans) and unsecured credit (personal loans or credit cards) demonstrates responsible credit behaviour and improves your score.
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With credit bureaus becoming more integrated into the financial ecosystem, it is imperative that borrowers are made aware of both their obligations and rights. Promoting a sound credit culture through enhanced consumer awareness and robust information systems can empower individuals to manage their credit behaviour more effectively.
The rise of consumerism is driving behavioural shifts, with products such as buy now, pay later (BNPL) encouraging borrowers to open multiple credit accounts. While convenient, such products can present challenges, ranging from difficulty in tracking spending to debt accumulation and missed payments. Recognising and managing these behaviours is essential for maintaining financial discipline and improving creditworthiness.
What if you have a low credit score?
A low credit score does not necessarily preclude access to financing. Some lenders use alternative credit evaluation methods or risk-mitigation tools such as mortgage guarantees to provide credit to such borrowers. However, these should be seen as enablers and not substitutes for sound credit behaviour.
Progressive financial instruments such as mortgage-guarantee-backed home loans are increasingly being adopted by both borrowers and FIs. A mortgage guarantee serves to mitigate credit risk by providing a first loss default guarantee (FLDG), thereby enhancing the lender’s confidence in extending credit to riskier customers. For borrowers, mortgage-guarantee-backed home loans can increase loan eligibility, enabling access to larger loans, longer tenures, and more manageable EMIs.
Also read: Why joint home loans could be a smart move for homebuyers
A credit score functions as a financial passport as it reflects an individual’s financial discipline, choices and reliability. By understanding and improving your credit score, you can make your home loan journey smoother, faster, and more cost-effective. Maintaining a strong score not only enhances loan eligibility but also provides long-term financial peace of mind.
Kanika Singh is chief risk officer at India Mortgage Guarantee Corporation.
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