Why is gross income important while applying for a personal loan?

When you apply for a personal loan, your credit score and a variety of other factors are checked in the background. This is done so as to ensure that you have a healthy spending habit, and you can repay the debt without any problem. One such metric that is also checked during this period is the gross income.

Naturally, if you have a greater gross income, the chances of your instant personal loan approval are extended. But why is it important and what does gross income mean? Let us take a deeper look into this. 

What is Gross Income?

Gross income includes all your earnings from various sources before any deductions. This encompasses your salary, bonuses, rental income, dividends, and any other sources of income. It’s the top-line figure that represents your total earning potential and financial health.

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What role does gross Income Play during Personal Loan Application?

Here is why gross income is important while applying for a personal loan:

Determines your personal loan eligibility

Lenders use your gross income to assess your ability to repay the loan. Higher gross income often translates to a higher likelihood of personal loan approval because it indicates a greater capacity to handle debt. Lenders typically have minimum income thresholds that applicants must meet to qualify for a personal loan. By evaluating gross income, lenders can quickly gauge whether an applicant meets their basic personal loan eligibility criteria.

Assess the Personal Loan Amount

The amount you can borrow is directly influenced by your gross income. Lenders usually offer loans based on a multiple of your annual income. For instance, if a lender’s policy is to lend up to 10 times an applicant’s monthly gross income and your gross monthly income is ₹50,000, you might be eligible for a loan of up to ₹5 Lakh. This ensures that the loan amount is proportionate to your financial capacity.

Helps to Calculate your Debt-to-Income Ratio

The debt-to-income (DTI) ratio is a crucial metric that lenders use to evaluate your financial stability. It is calculated by dividing your total monthly debt payments by your gross monthly income. A lower DTI ratio indicates that you have a manageable amount of debt relative to your income, making you a more attractive candidate to apply for a personal loan. For example, if your gross monthly income is ₹1,00,000 and your total monthly debt payments are ₹30,000, your DTI ratio would be 30%. Most lenders prefer a DTI ratio below 40%.

Determines the Interest Rate on your Personal Loan

Your gross income can also impact the personal loan interest rate offered by lenders. Applicants with higher gross incomes are often perceived as lower risk, which can result in more favourable interest rates. Conversely, if your gross income is lower, lenders might charge a higher interest rate to compensate for the perceived risk. 

Decide the Repayment Terms

Lenders use gross income to tailor the repayment terms to suit your financial situation. A higher gross income may afford you the flexibility of choosing between shorter or longer repayment periods, depending on your preference.

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Why do Lenders Focus on Gross Income while Applying for a personal loan?

Here is why gross income is important to the lenders:

To Check your Financial Stability

Gross income is often viewed as a stable and predictable measure of an applicant’s financial health. Unlike net income, which can fluctuate due to various deductions, gross income provides a consistent benchmark for assessing earning potential and hence, repayment potential as well.

To mitigate the risk

Lenders are in the business of managing risk. By examining gross income, they can mitigate the risk of lending by ensuring that the applicant has a sufficient financial cushion to handle loan repayments. This is particularly important in the case of unsecured personal loans, where there is no collateral to back the loan.

Regulatory Standards

Financial institutions must comply with regulatory standards that often require thorough assessment of an applicant’s ability to repay the loan. Gross income also forms a part of this comprehensive assessment, ensuring that lenders stick to responsible lending practices.

Thus, gross income is a fundamental component in the personal loan application process. In fact, you can be absolutely sure that any lender, be it a bank or an NBFC, will always check the gross income of the applicant before proceeding with the personal loan application. Higher gross income of the applicant automatically means that the person has the ability to repay the loan on time with EMIs, which makes them more favourable to the lender.