Before applying for a loan, know the factors a lender may consider before approving your personal loan. Though personal loans are the easiest form of debt available in the market, you still need to meet the eligibility criteria for availing a personal loan.
What factors do Lenders Consider for Giving you a Personal Loan?
A lender would want to ensure that you are financially capable of making timely loan repayment. Thus, they consider several factors before approving your loan:
Capability to Repay
The most important aspect is your financial stability. The lender will check if you have the financial capacity to pay back your loan with interest. Here, your income becomes an important factor; some lenders have a “minimum salary” requirement as a part of the Personal loan eligibility criteria.
Credit History & Credit Score
A healthy credit history leads to a good credit score and indicates good financial discipline. This score is generated based on the information in your credit report and shows your ability to pay off your debts. Based on your score, the lender decides whether to approve your loan. A score of 750 or above is desirable and will maximize the chances of loan approval.
Based on your credit score, some lenders decides your loan interest rates. If your score is higher, you may be able to negotiate a lower rate of interest for your loan, but a low score might get your loan rejected or approved at a higher interest rate.
Read More About : Factors Affecting Credit Score
You will be asked to submit proof of income with your application, and the lender may compare your expenses against your income to calculate your debt-to-income ratio. This ratio indicates your spending habits – another factor that lenders consider for loan approval.
A lender will be comfortable lending money to people with secured jobs, and thus a steady income. If you are switching jobs too often, it may raise a red flag for the lender.
Number of Existing Loans
The lenders scrutinize every aspect of your credit history, including the number of loans you have taken and the number of loans you are still paying off. Too many loans indicate financial instability.
Debt Consolidation & Balance Transfer can help you manage your existing debt better. Read more in our blog on: Complete Guide To Debt Consolidation
Your payment record is available in your credit history at CIBIL along with the payment dates. Lenders usually check these reports to see whether you have always or mostly made repayments on time. The lender may hesitate in approving your loan if your repayment history shows that you have frequently delayed EMIs or other due payments.
What is Debt-to-Income Ratio (DTI) ?
The DTI ratio indicates an individual’s ability to manage his/her debts and expenses from his/her income. This ratio directly affects your credit score and is a vital statistic used by lenders to evaluate an applicant’s creditworthiness. A higher DTI ratio shows that most of your income is spent in paying off your debts.
A healthy DTI (30%–50%) indicates that you are managing your money well, with enough being available to save and spend after making debt repayments.
Here are some tips to help you reduce your DTI ratio:
- If you reduce your EMI amount, your DTI ratio will go down. This is possible when you opt for a longer tenure for loan repayment.
- Increase in your gross income also brings down your DTI ratio. This could happen if you have any additional source of income or when your salary increases.
- Do not take fresh loans until you pay off the current ones. Any increase in debt increases your DTI ratio.
- Reducing your other fixed expenses can also have a positive effect on your DTI ratio. Don’t make unnecessary purchases until your debt is repaid. The amount saved could be used for down payments or prepayments of your loans.
- Keep a close watch on your expenses and your DTI ratio. This will help you track any expenditure pattern that is pushing up your DTI ratio and take remedial measures.
Always make sure that your DTI ratio stays below 40% to maintain good loan eligibility. Good financial planning can help you achieve a healthy DTI score.
Continue Reading : 5 Tips to Improve Loan Eligibility
Managing Your DTI with The 50-30-20 Rule
This rule was coined by Elizabeth Warren who was named by TIME magazine as one of the 100 Most Influential People in the World in 2010. It explains how you should spend and save your disposable income. This is the amount you will be left with after paying your taxes. She classifies the budgeting under the following three headings: needs, wants and savings.
This is how 50-30-20 rule works:
Spend 50% of the net income amount toward fulfilling your basic needs, such as rent, groceries, utilities, and transportation. Learn to understand the difference between your needs and wants. “Needs” are something that you require for surviving. For instance, you “need” a house to live in; but buying a fancy second house with a swimming pool is a “want” or a “luxury”.
Dedicate 30% of your net income toward your wants. Do the stuff you enjoy with this money; go for movies, travel, buy a new phone, and enjoy fine dining experiences.
Use 20% of your net income toward savings (saving for a trip, emergency fund, retirement corpus, etc.) and debt repayments.
For the 50-30-20 rule to work, you will need be very disciplined and strictly follow your budget. Keep track of all your expenses and investments. Even the slightest deviation could lead to a major budget failure. It is also advisable to revisit the budget plan with changing incomes and expenditures so that you continue to save and spend as per your changing financial scenario.
Human wants are unlimited, and it’s great to work toward achieving every aspiration. All you require is careful planning and execution of your financial goals. There are various credit products designed in a manner to help you manage your monthly cashflows. Make the most of these to live the life of your dreams!