Lending institutions, including both banks and Non-Banking Financial Companies (NBFCs), utilize a variety of factors to evaluate an individual's eligibility for a loan. These criteria are relatively consistent across most lending institutions and typically encompass factors like the applicant's credit score, age, income, occupation, and the profile of their employer. One commonly used method by lenders to calculate the approved loan amount is the Multiplier Method. In this approach, the loan amount is determined by multiplying a specific factor with the applicant's net monthly income. This factor can vary but typically falls in the range of 10 to 24 times the individual's monthly income. Another method utilized by lenders to evaluate loan amount eligibility is the EMI/NMI ratio. This ratio consists of two components: EMI and NMI. EMI, which is a more widely recognized term, stands for "Equated Monthly Installment." It represents the fixed monthly payments made by borrowers towards repaying the loan.
However, what exactly is NMI?
NMI stands for "Net Monthly Income." It is the net amount an individual earns on a monthly basis after accounting for deductions and taxes. Lenders consider the NMI as a fundamental component in assessing an applicant's loan eligibility. The EMI/NMI ratio is used to ascertain whether the borrower can comfortably manage the loan's equated monthly installments based on their net monthly income. This ratio assists lenders in making informed decisions regarding the amount of the loan that can be approved for an applicant, ensuring that the EMI payments remain within their financial means.
EMI/NMI Ratio:
The EMI/NMI ratio is calculated by dividing the borrower's monthly Equated Monthly Installment (EMI) by their monthly Net Monthly Income (NMI). Lenders use this ratio primarily to evaluate whether a borrower's NMI is sufficient to cover their monthly living expenses while also meeting their loan repayment obligations. In the calculation, banks take into account all EMIs related to existing loans and the proposed loan. Most lenders typically prefer applicants to maintain an EMI/NMI ratio of up to 50-55%. In certain cases, this percentage can be increased by including a co-applicant when applying for a loan.
The computation of the net monthly income can vary for salaried and self-employed individuals:
For Salaried Persons:
NMI comprises the total statutory deductions such as provident funds and similar items deducted from their salary.
For Non-Salaried Persons:
Since the monthly income for non-salaried individuals may not follow a regular pattern, NMI is calculated based on Net Annual Income (NAI). This essentially means the annual income as per the latest income tax return filed by the individual.
The EMI/NMI ratio can range from 20% to 70%, depending on the applicant's net annual income. The majority of lending institutions establish an upper limit on the EMI/NMI ratio. Typically, the maximum loan amount is determined in a manner that ensures the EMI/NMI ratio remains within the predefined boundaries. However, it's worth noting that applicants with exceptional credit profiles may receive special consideration. Some banks may authorize local sanctioning officers to relax the EMI/NMI ratio limits to a certain extent.
Example: To illustrate this with an example, let's consider Mr. X. Suppose a bank offers him a 25% EMI/NMI ratio based on his income slab. In this case, the maximum EMI amount that Mr. X can opt for is 25% of INR 1,15,000, which equals INR 28,750. However, if Mr. X decides to invest Rs. 5,000 in a new monthly SIP scheme, the maximum EMI amount he can afford is reduced to INR 23,750 (INR 28,750 - INR 5,000).
Why is NMI Important?
Monthly income, often referred to as Net Monthly Income (NMI), holds a significant role in the loan eligibility assessment process. The importance of NMI stems from the fact that the EMI/NMI ratio varies for different monthly income brackets. Consequently, an individual with a higher monthly income has the potential to secure a larger personal loan amount, assuming they don't have existing financial obligations such as credit card EMIs. NMI serves as a key determinant in evaluating an individual's loan eligibility, as it directly influences the EMI/NMI ratio. A higher NMI allows for a more substantial EMI commitment, which can translate into a larger loan amount approval. However, it's important to note that this is contingent on the individual's capacity to meet the EMI obligations without compromising their financial stability.
The primary consideration for lenders when assessing a loan application is to gauge the individual's repayment capacity. Virtually every lender adheres to a predetermined standard regarding the required monthly income. From the customer's perspective, the EMI/NMI ratio serves as a crucial tool in determining the maximum loan amount that can be borrowed based on the Net Monthly Income (NMI), accounting for existing liabilities, which may include the new loan EMI. Typically, lenders grant personal loans to applicants who maintain an EMI/NMI ratio within the range of 50-55%.
