Healthy credit history gives you a better chance of securing a loan

I am a 31-year-old professional with an annual package of Rs9,00,000. Recently, I settled two credit cards outstanding and got zeroised statement (which mentioned my outstanding as zero in both the accounts) from their side after making the payments. Right now, with two personal loan accounts still on, I am paying monthly EMI of Rs13,000 collectively. I wish to apply for a home loan in September 2011. Will those settlements affect my credit history?
Ensuring that you have no outstanding amount on your credit card is always a good practice, but it would depend on the actual circumstances of your “settlement”. For example, if you had a current balance of Rs20,000 and were paying minimum payments regularly and on time, your credit history is still healthy. If you have gone one step further and paid down that current balance in full, your credit history may be viewed more favourably by a loan provider.

However, take a situation where the bank believes you owed Rs20,000 on the credit card but you were of the opinion that you only owe Rs15,000. Hence, you pay Rs15,000. This is accepted by the bank as payment and it closes your credit card account. The bank may then report your account status as “settled” to the credit bureau which may be viewed negatively by a loan provider when reviewing your Credit Information Report.

Hence, if you are in the former situation, the home loan providers may view your loan application more favourably. However, if you are in the latter situation you may find that your loan application may face some obstacles.

Can the EMIs for my personal loan accounts create a negative impact on my application for a home loan?
Whether or not the EMIs on your personal loans will have an effect on your loan application will depend on a number of other factors such as your monthly take home income, the size and tenure of the loan you are looking for and the number of dependants in your household (which affects your monthly living costs).

One of the most important factors is your EMI to income ratio, which is the percentage of your monthly income that you spend on servicing debt obligations. If this ratio exceeds 50%, it may hamper your loan application. This is best explained with an example.

Assume your take home income is Rs50,000 and your outflows are as follows:
EMI on Personal Loans: Rs13,000
Living Expenses (rent, general consumption, etc): Rs25,000
This would mean your total outflow in the month is Rs38,000 with an EMI to income ratio of 26% (13,000 / 50,000). Hence, the additional EMI you will be able to comfortably service (while keeping the ratio within 50%) would be approximately Rs6,000 to Rs8,000 each month (leaving a cushion for some emergency expenses). Hence, a loan provider may only be comfortable lending an amount of approximately Rs6,00,000 (calculation made for a 15-year tenure at an interest rate of 10%).

This is a general rule of thumb and it is important to note that the criteria will differ between lenders.

The writer is senior vice-president-consumer relations, Cibil (www.cibil.com). You can reach him at creditwise@cibil.com