In February 2023, outstanding personal loans in India had crossed the ₹40 lakh crore milestone. Availing a personal loan in India is a very simplified process today thanks to mobile banking apps and 24/7 customer service; however, borrowers must know about the various factors that influence their eligibility of these personal loans. The debt-to-income ratio is a key metric that helps banks and financial institutions decide the ability of an individual to repay a personal loan.
How do banks analyse a borrower’s Debt-to-Income ratio?
Borrowers can calculate a debt-to-income ratio by dividing an applicant’s total Equated Monthly Installments (EMIs) by their gross monthly income; a ratio that determines whether a borrower is financially capable of assuming additional debt. Banks and financial institutions use this ratio to determine a candidate’s affordability of their personal loans.
Key points regarding the debt-to-income ratio that borrowers must know:
- Banks generally prefer a debt-to-income ratio that is lower than 40%:
Banks and NBFCs (Non-Banking Financial Companies) prefer individuals whose debt-to-income ratios are lower than forty per cent. A low debt-to-income ratio indicates the borrower’s capability to repay a personal loan alongside their existing financial obligations. A ratio above 40% may concern lenders, signaling that the borrower might be at a higher risk of default.
- Debt-to-income ratio affects personal loan interest rates:
Banks and financial institutions also consider a candidate’s debt-to-income ratio to determine the interest rate applicable on their personal loan. Lending institutions offer personal loans with low interest rates to applicants with low debt-to-income ratios.
- Banks use the debt-to-income ratio to evaluate a candidate’s application:
Borrowers with a lower debt-to-income ratio generally qualify for loans with higher principal amounts. On the contrary, borrowers with higher ratios might be eligible for a reduced loan amount.
Benefits of using a personal loan EMI calculator:
Borrowers who wish to avail personal loans can gain a significant advantage using a personal loan EMI calculator. These online tools are easily accessible and provide borrowers valuable insights into their future loan repayment schedule. Here are a few key benefits of using a personal loan EMI calculator:
- Borrowers can plan for their future expenses:
Personal loan EMI calculators allow borrowers to determine the exact amount they must pay monthly to repay their loan. This foresight enables better financial planning and budgeting, as borrowers can anticipate and manage their future expenses more effectively.
- Borrowers can compare loans online:
EMI calculators also provide the opportunity to compare the EMIs of different loan amounts and tenures. Borrowers can compare loans by adjusting loan tenures to find the right balance between monthly payments and repaying their personal loan.
The debt-to-income ratio indicates a borrower’s capacity to assume additional debt. The ratio also impacts a borrower’s credit score and helps them demonstrate their loan-repaying capacity to a lender. Borrowers can benefit greatly from using personal loan EMI calculators to plan their financial future effectively. They can use these tools to plan for their future expenses by accounting for their personal loan repayment.