How Personal Loan Debt Can Affect Your Home Loan Eligibility

Imagine you’re ready to buy your dream home. You’ve found the perfect property and plan to apply for a home loan. But there’s a problem, you already have a personal loan with a big monthly EMI. How will this affect your chances of getting a home loan?

In India, personal loan debt has been increasing quickly. As of March 2024, household debt reached ₹120 trillion, a huge jump from ₹77 trillion in June 2021. This rise in debt makes it harder for borrowers to manage new loans.

Lenders check your debt-to-income (DTI) ratio, the percentage of your income that goes towards paying off debts. If a large part of your income is already committed to EMIs, lenders might hesitate to approve your home loan.

In this blog, we’ll explain how personal loan debt impacts home loan eligibility and share smart ways to improve your chances of approval.

How Personal Loan Debt Can Affect Your Home Loan Eligibility

Personal loan debt increases your DTI ratio, affects your credit score, and raises financial strain, making it harder to qualify for a home loan.

Let’s break down how each factor matters and easy tips to improve your chances.

Debt-to-Income (DTI) Ratio: The Primary Factor

The DTI ratio compares your total monthly debt payments to your total monthly income. It helps lenders understand whether you can handle more debt. A higher DTI means more of your income is already going towards existing debts, like personal loans, car loans, or credit card payments.

How to calculate DTI:

The formula is: DTI Ratio = (Total Monthly Debt Payments / Total Monthly Income) x 100

Read More - Best Year to Take a Home Loan

Example:

Total EMIs = ₹15,000 + ₹10,000 = ₹25,000

DTI ratio = (₹25,000 / ₹1,00,000) x 100 = 25%

Most banks in India prefer a DTI ratio below 40%. A DTI ratio above this limit means your chances of getting a home loan may decrease.

Why does DTI matter?

Lenders think twice about approving a home loan if a large part of your income already goes towards existing debts. Even if you have a high salary, too many loans can reduce your chances of loan approval.

Quick Tip:

Before applying for a home loan, try to reduce your DTI ratio by paying off smaller debts or increasing your income.

2. Impact on Credit Score

Your credit score is a number between 300 and 900 that shows your creditworthiness. Lenders use this score to check if you are responsible with loans. A higher score (750 and above) means better chances of getting your home loan approved.

How does personal loan debt affect your credit score?

• Timely payments: Paying your personal loan EMIs on time improves your credit score.
• Missed payments: Missing EMIs lowers your score and damages your loan eligibility.
• Too many loans: Having multiple loans at the same time can also reduce your score.

Imagine you have a personal loan of ₹5,00,000. You’ve paid all EMIs on time, which improves your credit score to 780. Now, when applying for a home loan, the bank sees your good credit history and approves your loan easily.

But if you miss even a few EMIs, your score could drop to 650, making lenders think twice about offering you a loan.

How to improve your credit score:

• Always pay EMIs on time.
• Avoid taking too many loans at once.
• Don’t use too much of your credit card limit (keep usage below 30%).

3. Reduction in Loan Amount Eligibility

Your personal loan can reduce the amount of home loan you qualify for. Since banks consider your existing EMIs while calculating how much you can afford, higher debt can lower your loan eligibility.

Let’s say you earn ₹1,00,000 per month and want a home loan. Here’s how personal loans can reduce your eligibility:

Why does this happen?

Banks calculate your loan eligibility by subtracting your current EMIs from your total income. The higher your existing EMIs, the less income you have left for paying the home loan EMI. This reduces the amount banks are willing to lend.

Quick Tip:

Close any small loans before applying for a home loan to increase your loan eligibility.

4. Higher Interest Rates on Home Loans

When you apply for a home loan, banks check your financial history to decide what interest rate to offer. If you have existing debts, such as a personal loan, banks may see you as a higher-risk borrower. This can lead to a higher interest rate on your home loan.

Why does this happen?

Lenders assume that if you already have ongoing loans, there’s a higher chance of delayed payments or defaults due to financial stress. To cover this risk, they charge you a higher interest rate.

Example:

• Without any personal loan: You apply for a home loan of ₹40,00,000 at an interest rate of 8%. Your EMI will be around ₹33,458 (for a 20-year tenure).
  
  
• With an existing personal loan: You apply for the same home loan, but because of your ₹5,00,000 personal loan, the interest rate increases to 8.5%. Now, your EMI becomes ₹34,599.

Over 20 years, that extra 0.5% could cost you an additional ₹2,73,000 in total repayments!

Quick Tip:

Before applying for a home loan, try to pay off or reduce your personal loan balance. A lower outstanding debt can help you negotiate better interest rates.

Also Read - Home Loan Interest Rate Comparison

5. Effect on Loan Tenure

The loan tenure is the time period over which you’ll repay your home loan. Typically, home loans in India have tenures ranging from 10 to 30 years. But having personal loan debt can affect the tenure the bank is willing to offer you.

Why does this happen?

If a large part of your income goes towards repaying existing loans, banks might limit the tenure to reduce the risk of delayed payments. Shorter tenures mean higher EMIs, which can strain your budget.

Example:

Imagine you want a home loan of ₹30,00,000 and prefer a 20-year tenure, which means an EMI of ₹25,000 per month (at 8% interest).

• If you already pay ₹15,000 for a personal loan EMI, your total debt will be ₹40,000 per month.
• The bank may decide that this is too much risk and reduce your home loan tenure to 15 years instead of 20.
• Now, your EMI increases to ₹28,688 per month, which might stretch your budget further.

Quick Tip:

If possible, close your personal loan early or choose a longer tenure for your personal loan to reduce the EMI burden. This way, banks will be more willing to offer you a longer home loan tenure.

6. Loan-to-Value (LTV) Ratio Adjustments

The Loan-to-Value (LTV) ratio is the percentage of the property’s value that a bank is willing to finance through a home loan. The rest of the amount must be paid as a down payment by you.

For instance, if a property costs ₹50,00,000 and the bank offers an LTV of 80%, you can get a loan of up to ₹40,00,000, while you’ll need to pay ₹10,00,000 as the down payment.

How does personal loan debt affect the LTV ratio?

When you have high existing debt, banks may reduce your LTV ratio to lower their risk. This means you’ll need to pay a higher down payment from your pocket.

Example:

If you already have a personal loan, the bank might offer an LTV of only 70% instead of 80%. This means you’ll need to arrange ₹5,00,000 more as a down payment.

Why do banks reduce the LTV ratio?

If you have high existing debts, banks prefer to limit their risk exposure. A lower LTV ratio ensures that you have more financial commitment towards the property, reducing the risk for the bank.

Quick Tip:

Plan for a higher down payment if you have an existing personal loan. This could help you secure the loan even if the bank offers a lower LTV ratio.

7. Requirement for Higher Down Payment

When you apply for a home loan, banks usually finance a certain percentage of your property’s value. This is called the Loan-to-Value (LTV) ratio. The rest of the amount has to be paid upfront by you as a down payment.

How does personal loan debt affect your down payment?

If you have a high personal loan debt, banks see you as a riskier borrower. To reduce their risk, they might lower the LTV ratio, meaning they’ll finance a smaller part of the property’s cost. This forces you to pay a higher down payment.

Let’s say you want to buy a house worth ₹50,00,000.

In this case, if you already have a personal loan, the bank reduces your LTV ratio to 70%. You’ll now need to arrange ₹15,00,000 as a down payment instead of ₹10,00,000.

Quick Tip:

Pay off small debts before applying for a home loan. This increases your chances of getting a better LTV ratio.

8. Stricter Eligibility Criteria

Banks have stricter rules for people who already have loans. They assess whether you can handle both your personal loan EMI and the new home loan EMI together.

What do banks check?

• Debt-to-Income (DTI) ratio: The percentage of your income that goes toward paying debts.
• Credit score: A score above 750 increases your chances of approval.
• Income stability: A steady job or business income improves your eligibility.

Imagine your monthly income is ₹80,000. You already have a personal loan EMI of ₹20,000. The bank might feel you cannot afford another EMI of ₹25,000 for a home loan. In this case, your eligibility reduces, or your loan request may be rejected.

Quick Tip:

Increase your income through a part-time job or freelance work. It improves your eligibility for a higher home loan amount.

How to Improve Home Loan Eligibility Despite Personal Loans

If you already have a personal loan, here are some smart ways to improve your chances of getting a home loan:

1. Clear small debts: If you have smaller loans or credit card bills, pay them off before applying.
2. Increase your income: A side business or part-time job can increase your income, improving your DTI ratio.
3. Choose a longer loan tenure: A longer tenure reduces your monthly EMIs, improving your DTI ratio.
4. Consider a joint loan: Apply with your spouse or family member to increase combined income and loan eligibility.
5. Negotiate better terms: If you have a good credit score, negotiate with lenders for lower interest rates.

Conclusion

Personal loan debt can impact your home loan eligibility, but there are several strategies you can implement to improve your chances of securing approval. By following the above steps, you can reduce your debt burden and present yourself as a more attractive borrower to lenders.

Before applying for a home loan, assess your financial situation and make any necessary adjustments to improve your eligibility. With careful planning and the right strategies, you can overcome the challenges posed by personal loan debt and secure the home loan you need.

FAQs

How does personal loan debt affect my home loan eligibility?

Personal loan debt increases your debt-to-income ratio, affecting your ability to repay a home loan.

Can I apply for a home loan if I have a personal loan?

Yes, but it may reduce your eligibility depending on the size of the personal loan EMI and your income.

Will clearing my personal loan improve my home loan chances?

Yes, paying off your personal loan helps reduce your debt-to-income ratio and increases your eligibility for a home loan.

How does my credit score affect my home loan eligibility?

A good credit score (700+) improves your chances of securing a home loan, even with personal loan debt.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?