This is how a bank lends money
By Joseph Samson
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The 3 methods used to arrive at eligibility:
  1. Instalment to income ratio

    This ratio is generally expressed as a percentage. This percentage denotes the portion of the customer's monthly instalment on the home loan taken. Usually, banks use 33.33 percent to 40 percent ratio. This is because it is has been observed that under normal circumstances, a person can pay an instalment upto 33.33 to 40 per cent of his salary towards a loan.

    For example, if we consider the instalment to income ratio equal to 33.33 per cent, and assume the gross income to be Rs 30,000 per month, then as per the ratio, the applicant is eligible for a loan with the maximum instalment of Rs 10,000 per month.

  2. Fixed obligation to income ratio

    This ratio signifies the importance of the regularity in the repayment of previous loans. In this calculation, the bank considers the instalments of all other loans already availed of by the customer and still due, including the home loan applied for. In other words, this ratio includes all the fixed obligations that the borrower is supposed to pay regularly on a monthly basis to any bank. Statutory deductions from salary like provident fund, professional tax and deductions for investment like insurance premium, recurring deposit etc. are exempt from these fixed obligations.

    As an example, assume that monthly income of an applicant is Rs 30,000 and the applicant has a car loan instalment of Rs 4,000 per month, a TV loan instalment of Rs 1,000 per month. In addition to this his proposed housing loan instalment is Rs 10,000 per month. Numerically, the ratio is equal to Rs. 15,000 or 50 percent (i.e. 50 percent of the monthly income). If the bank has decided on the standard of 40 per cent of ratio as the criteria, then the maximum total instalments the person can pay, as per the standard, would be Rs 12,000 per month. As he is already paying Rs 5,000 for the car and TV, he only has Rs 7,000 left out. Hence, the customer would be given only that loan for which the EMI would be equal to Rs 7,000, keeping in mind the repayment capacity of the applicant.

  3. Loan to cost ratio

    This ratio is used by banks to calculate the loan amount that an applicant is eligible to pay on the basis of the total cost of the property. This ratio sets the upper limit or the maximum loan amount that a person is eligible for, irrespective of the loan eligibility under any other criteria. The maximum amount of loan the borrower is eligible to pay is pegged as equal to the cost or value of the property. Even if the banks’ calculations of eligibility, according to the above mentioned two criterions, turns out to be higher, the loan amount can't exceed the cost or value of the property. This ratio is set equal to between 70 to 90 per cent of the registered value of the property.

Hence, while deciding on the maximum amount of loan a customer can be given, the banks use these three parameters. These parameters help in computing loan eligibility, which is crucial in calculating the creditworthiness of a customer. It also acts as a guide to determine the loan amount.

However, if all the three ratios yield a different value, which is commonly the case, what do the banks do?

Simple, they generally select the lowest of the three as the loan amount that the applicant is eligible to pay.

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