We all have life goals, don't we? Whether it's the dream of owning a home or car, going on a vacation abroad, buying your favourite gadget or any other goal that we wish to tick off from our bucket list. While the list and order of priority would certainly vary for each one of us, one common element that takes us a step closer to these goals, is loan. Although it's better to go for a well-thought investment plan to achieve life goals to the extent possible, loans often act as our gateway to achieve some goals, especially the big-ticket ones like home loans or personal loans that bail us out during financial emergencies.
So, given that loans are something almost all of us might require at some point in our lives to bridge the gap between our financial goals and even mitigate exigencies, it becomes prudent to follow the right set of steps to avoid getting your loan application rejected. Curious to know the way ahead? Read on as we unfold a five-point checklist everyone should tick off before applying for any loan.
Your credit score is a three-digit numerical representation of your credit repayment behaviour, primarily based on your past and current loan and credit card accounts¡¯ repayment history, amongst other factors. As your credit score gives lenders a fair idea about your creditworthiness, it is amongst?the first factors taken into consideration by financial institutions when evaluating your loan application. Generally, applicants with a credit score of 750 and above tend to have higher chances of not only getting the loan approved but even fetching lower interest rates as well.
Hence, having a good credit score makes you credit ready to avail a loan whenever the need arises. That's why it becomes imperative to build and maintain a good credit score, besides periodically reviewing your credit report as well, especially when planning to apply for a loan in near future. Doing so would help you take any corrective steps towards your credit score if need be, and then apply later with an improved credit profile to boost approval chances of loan and credit cards.?
Also Read:?Why Your Credit Score Can Fall Despite Timely Payments!
Your emergency fund is meant to?act as a cushion to fall back on when?unforeseen financial exigencies or income disruptions arise, like job loss, severe illness?or disability. And the size of this rainy day fund should ideally?be capable of meeting your monthly mandatory?and recurring?expenses, including your rent, SIPs, loan EMIs?etc.?for at least six months.?
So, it becomes prudent to proportionally increase the size of your emergency fund equivalent to at least six EMIs of your soon to be taken loan. Including your new EMIs into emergency fund allows you to continue with your loan EMI repayments during adverse financial situations wherein you may face difficulty in loan repayments, which would otherwise make you incur late payment penalties, increased interest, adverse impact on your credit score and at worst, even lead to a loan default. Also, when it comes to arriving at your expected EMI amount, you can make use of the online EMI calculator tool offered by most lenders and financial portals. This would help you get an estimate of your expected EMI as per the loan amount, chosen tenure and applicable rates offered by lenders.
Also Read:?Does It Make Sense To Maintain Emergency Fund If You Have A Big Bank Balance And Investments
The next step is to assess your repayment capacity by factoring in your EMI affordability. Generally, lenders evaluate your loan repayment capacity by checking your EMI to income ratio, which may vary across lenders and loan options. But broadly saying, your EMI to income ratio should ideally not cross the 50%-60% mark, beyond which it depicts a high imbalance between your income and debt obligations, hence raising the chances of default.?
To check your EMI to income ratio, divide your total EMIs (including the proposed new loan) by your net monthly income. In case your monthly EMI obligations breach the 50-60% mark, then first try and pull down this ratio before applying for a new loan, as the chances of loan rejection might be high in the presence of a high EMI to income ratio.?You can lower your EMI to income ratio in multiple ways, like prepaying your existing loan, getting the existing loan¡¯s tenure extended to reduce the monthly EMI outgo or increasing your monthly income.
More often than not, we tend to not pay much attention to the tenure we are choosing for a loan, which often results in a mismatch between the loan EMI amount and the borrower¡¯s repayment capacity. That's why being wise when choosing your loan tenure is a simple but crucial step we all should take when applying for a loan. Remember, your choice of tenure directly impacts your monthly outgo in the form of EMIs. The shorter the tenure, the bigger the EMI amount, whereas the longer the tenure, the smaller the EMI amount. While this may sound like a win-win case for long tenures, it's important to note here that the longer your tenure is, the higher your overall interest outgo is.
And in the case of shorter tenures, although the interest outgo is lower, the EMI amounts are bigger, which can put a strain on your finances or make you compromise on other life goals and loan EMI plus investment contributions like SIPs.
So, which tenure to choose? The basic thing to keep in mind is to select the tenure whose corresponding EMI you are comfortable to repay, which is most likely to be the lower EMIs involved in longer tenures. In that case, you can combat the issue of the higher interest cost of long tenures by making prepayments, whenever you have surplus funds. This way, you would be able to repay the smaller EMIs and also lower the overall interest cost!
Whenever the thought of applying for a loan strikes your mind, whether as a planned process or a relatively instant one to tackle financial exigencies, doing your homework regarding the choice of loan and lender is a must in both cases. Simply put, firstly, do not zero in on a particular loan option without enquiring or exploring other alternatives. Secondly, compare various prospective lenders, like banks, NBFCs, fintech, etc before submitting your loan application to any. For both these cases, the key reason behind doing your homework is that the interest rate, tenure, loan amount, LTV ratio, processing fees, etc. varies across a wide array of loans and lenders. Hence, it becomes imperative to thoroughly compare various loan options and lenders in order to arrive at the most suitable one as per your eligibility and financial requirement.
Also Read:?How Millennials Can Kickstart 2022 On A Financially Strong Note
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