FINANCIAL RADIANCE
FINANCIAL RADIANCE
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This could be your first time when you are buying a property and are very excited. You decide that you have enough money for the down payment, you go to the bank to take a loan and then you get a shock that you are not eligible for that much loan. Obviously, this would be very devastating as now the dream home could become out of bounds. Have you ever wondered how your loan eligibility becomes different when you approach one bank versus another bank? In this blog, I will discuss the loan eligibility calculator, so that you are well prepared to respond appropriately during the documentation process. In future blogs, I will talk about how you can increase your loan eligibility.
This will be true for all types of loans, but since the home loan is most common and is also taken for a large amount, that will remain the focus.
This simply means how much is the maximum loan amount that the bank will be willing to provide to you. Earning a high income does not translate into higher loan eligibility. After all, the bank has to keep its interest (pun intended) in mind too when they disburse the loan. There are many criteria that the bank would look at before deciding how much of a loan they can lend.
Loan eligibility is calculated based on the net income a person gets home. That is a no brainer. Let’s get into the calculations. Banks decide that they will give a loan up to x% of net income. How much that “x” varies from bank to bank. It could be in a range from 30% to say up to 50% for different banks. This is assuming that you would be spending money on your various household expenses which could vary between 50% to 70% of your net income. Banks certainly don’t want to get into a situation where their borrower is not able to pay the equated monthly installments (EMI) which could eventually make the loan amount a Non-Performing Asset (NPA) in their books which they will then eventually need to write-off.
So, as an example let’s assume you approach the bank for a loan of Rs 1 lakh. Considering the interest rate of 7.5% and tenure of say 20 years, the EMI works out to be approximately Rs 800. This is the “PMT” formula in the Excel sheet. Now, assuming your net income is Rs 1 lakh and the bank considers max of 50% as EMI which they think you can afford, then for a Rs 50,000 EMI, the loan would be approximately Rs 62.5 lakhs.
Loan eligibility = (Net Savings/EMI per lakh) * 100,000
So, in this example, Loan eligibility = Rs (50,000/800) * 100,000 = Rs 62.5 lakhs
Please note that in this example, the existing EMIs on various loans have not been considered. So, if the person has other EMIs (vehicle, personal loan etc.) then the total of those EMIs will first we subtracted from the EMI, the bank is willing to accept from you (Rs 50,000 in this example), and then the loan eligibility is worked out.
Loan eligibility parameters (not an exhaustive list)
Now let’s look at the major factors the bank would look at when they are processing your loan application. Please note that this list is not exhaustive.
As mentioned previously, net income is one of the most important parameters for deciding the loan eligibility. Other than the net income, banks would also look at the reputation of the company where you work and how long you have been working with them. In fact, if you are working with one of the companies which are listed with them, you may be eligible for a lower interest rate. Certain industries or professions could be in the negative list of the bank and they may decide not to extend the loan. Also, a self-employed person may have a higher interest rate or may find it difficult to get the loan considering the irregularity of the cash flows. The documentation needed for a self-employed person would be much more since the bank would not only need the past few years’ Income Tax Return (ITR) copies but may also need other documents such as P&L and Balance Sheets certified by a Chartered Accountant (CA).
I have mentioned in various blogs in the past, how important is the credit history of the applicant whenever a loan is taken. Someone with a low credit score or a bad payment record will find it difficult to get a loan or may be provided at a much higher interest rate. Any bad remarks on previous loans such as “Written off” or “Settled” in CIBIL’s report will certainly put the application in a bad light.
A higher duration of the loan means a greater risk for the bank since there could be default over a long period. But a bank would still be fine giving a loan for 20 years to a 40-year-old person, to as compared to someone who is 50 years old, since this person is much closer to the retirement and then the cash inflows could stop and therefore a greater risk for the bank.
The lower the debt to income ratio, the higher would be the chances of getting the loan sanctioned by the bank. This is because the EMIs would be low and the bank would perceive your net savings to be higher.
If you have maintained the same bank account for many years and your relationship has been good, banks would want to consider your loan favorably if all other aspects as mentioned above have been positive.
While we have considered home loans as an example, for other types of loans also the criteria would be very similar. For a personal loan, it could be even stringent as it is an unsecured loan and this also explains why banks charge a higher interest rate for it since their risk is higher.
Need a higher loan than what the bank as determined for you? In our next blog, we will discuss how loan eligibility can be increased and you can still afford the dream house you have been eyeing for a long time. So, keep watching this space!
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