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Balancing EMIs and income

There are few who think about the manner in which they will repay before deciding on taking a loan, writes Arnav Pandya.

india Updated: Jan 10, 2008 20:23 IST
Arnav Pandya
Arnav Pandya

Taking a loan is the easier part of the entire process. Most people spend a lot of time thinking about the way in which the loan amount will be spent. There are few who actually think about the manner in which they will repay the loan before deciding upon taking it. There is one such measure that people should know and understand so that they have an idea about the pressure that their finances are under.

EMI to income ratio

A person receives a specific amount as his income and this is the pool from which he will be making the EMI payment against loan. There is a need to know the ratio of the payment to income as it will help understand the pressure that the income pool will come under while paying regular installment.

The ratio is arrived at by dividing the EMI figure from the income and multiplying the amount by 100. What the ratio shows is the percentage of income that goes towards the repayment of EMI and the extent of safety for the person in terms of the difference of income.

Take all the loans

Several people make the mistake of looking at a particular loan in isolation when they make this calculation. For example, if the income of a person is Rs 40,000 a month and the loan EMI is Rs 12,000 then the ratio will be 30 per cent and this might not seem high.

However if there is another loan of a similar EMI, then the figure will show a severe stress because it will cross the 50 per cent mark. Only when all the figures are taken together will the person be able to determine the kind of impact it will have on his income and whether the loan needs to be restricted.

Calculate income by receipts

Another thing to keep in mind is that the income figure should not be the cost to company figure. There are various ways in which this can be calculated.

Only gross income should be taken into account because this will show the extent of the earnings. Again, with the gross figure, deductions like taxes and other statutory payments should be calculated to understand the actual impact on the income. If the income base is not calculated correctly, the ratio will not give the exact picture.

Interpreting the ratio

The incidence and the impact of the ratio depend upon the way in which a particular person is placed. For example, if the ratio goes higher than 40 per cent then it's a cause for concern.

Many who do not have high expense and are adding assets might be comfortable with a 35 per cent, others might find 25 per cent more comfortable.

The only idea is that the ratio should not go so high that it becomes difficult to make these payments in case there is a slight impact on the income of the person.