How to Calculate Personal Loan Eligibility Based on Salary

Introduction

Securing a personal loan can be a straightforward process, but understanding how much you are eligible to borrow requires some financial calculations. Personal loan eligibility often depends on various factors, but salary is one of the most crucial determinants. Lenders evaluate your monthly income to assess your repayment capacity, and your loan eligibility is calculated accordingly. This article will break down the methods used to determine personal loan eligibility, focusing specifically on income-based calculations, while also considering other influencing factors like expenses, credit score, and loan tenure.

Understanding the Basics of Personal Loan Eligibility

Before delving into detailed calculations, let’s define some key elements involved in determining personal loan eligibility:

• Net Monthly Income (NMI): The income you receive after taxes and deductions. Most lenders use this amount to assess how much you can repay every month.
• Fixed Obligations to Income Ratio (FOIR): This refers to the percentage of your income that is already committed to fixed obligations like rent, existing EMIs (Equated Monthly Installments), and other debts. Lenders usually prefer to see a FOIR of less than 50%.
• Loan Tenure: The length of time over which the loan will be repaid. A longer tenure means smaller monthly EMIs but more total interest paid.
• Interest Rate: The rate charged by the lender for providing the loan, which influences how much you end up paying in total interest.

Step-by-Step Calculation of Personal Loan Eligibility Based on Salary

Step 1: Determine Your Net Monthly Income (NMI)

The first step in calculating personal loan eligibility is to figure out your Net Monthly Income (NMI). For salaried employees, this is the take-home pay after deductions such as taxes, provident fund, and insurance.

Example: If your gross monthly salary is $5,000 and after tax deductions and other commitments, your take-home salary is $4,000, then your NMI is $4,000.

Step 2: Identify Fixed Obligations (FOIR)

Next, you need to identify all your existing financial commitments, such as rent, car loans, and other EMIs. The sum of these amounts will help calculate your FOIR.

Example: Suppose you have the following fixed obligations:

• Rent: $1,000
• Car Loan EMI: $500
• Credit Card Payments: $300

In this case, your total fixed obligations amount to $1,800.

Step 3: Calculate Disposable Income

Once you know your FOIR, subtract it from your NMI to calculate your Disposable Income. This will give an indication of how much of your income can be directed toward repaying the personal loan.

Formula: Disposable Income = NMI - Fixed Obligations

Example: If your NMI is $4,000 and your fixed obligations are $1,800, then your disposable income is: $4,000 - $1,800 = $2,200

Step 4: Determine Maximum EMI Affordability

Lenders typically allow a certain percentage of your disposable income to be allocated toward the EMI of a new personal loan. This percentage varies but is generally around 40% - 50% of your NMI.

Formula: Maximum EMI Affordability = Disposable Income * FOIR Limit

Example: If your disposable income is $2,200 and the lender allows 50% of your income to be used for EMI payments, your maximum EMI affordability is: $2,200 * 50% = $1,100

This means that you can afford a maximum EMI of $1,100 per month for a new loan.

Step 5: Estimate Loan Amount Using EMI Formula

Finally, you can estimate your loan eligibility by using the EMI formula. The formula used to calculate EMI is:

EMI = [P * r * (1 + r)^n] / [(1 + r)^n - 1]

Where:

• P = Principal loan amount (i.e., the loan you are eligible for)
• r = Monthly interest rate (annual interest rate divided by 12)
• n = Number of months (loan tenure in years multiplied by 12)

Rearranging this formula allows you to calculate P, which is the loan amount you can borrow.

Example: If the interest rate is 10% per annum (or 0.0083 per month), and you plan to take a personal loan for a tenure of 5 years (or 60 months), and your maximum EMI affordability is $1,100, then you can calculate the principal loan amount:

Using the formula, P ≈ $50,000

This means, based on a $1,100 EMI, 10% interest rate, and 5-year tenure, you are eligible for a loan of approximately $50,000.

Additional Factors Influencing Loan Eligibility

Apart from salary, other factors also influence your loan eligibility, such as:

• Credit Score: A high credit score (above 750) increases the likelihood of loan approval and might even get you better interest rates. A low score can reduce your eligibility or even lead to rejection.
• Age: Younger applicants tend to have higher eligibility due to their longer working years, whereas older individuals may be offered shorter tenures.
• Employer and Job Stability: Lenders consider applicants employed by reputed firms or government entities as lower risk, which can improve eligibility.
• Existing Liabilities: If you have multiple loans or high credit card debt, your eligibility might decrease due to the high FOIR.

Real-World Examples of Loan Eligibility Based on Different Salaries

Conclusion

Calculating personal loan eligibility based on salary involves a step-by-step assessment of your income, fixed obligations, and the EMI affordability, followed by a calculation of the loan amount using standard financial formulas. While salary is a significant factor, credit score, tenure, and fixed obligations also play crucial roles in determining how much you can borrow. It is essential to ensure that you maintain a healthy credit profile and limit your fixed obligations to increase your loan eligibility. Use the information outlined above to estimate your eligibility and make an informed decision when applying for a personal loan.