Applying for any sort of financing facility, be it a credit card or a home loan, should be a conscious and calculated decision. Any time you apply for a loan, you go through a rigorous credit appraisal process (more on what this does to you at the end of this article). Let’s assume you have met the minimum age and income requirements for a certain product, for example, a personal loan. Once you apply, the bank proceeds to evaluate your credit worthiness. One of the key documents banks use in this process is your eCIB report.
The Electronic Credit Information Bureau (eCIB) was established in 1992 by the State Bank of Pakistan to maintain credit reports of all consumers and corporations in Pakistan. All banks and other lending institutions are members of this database and share information with each other to improve their credit appraisal processes. Member banks are required to submit borrowers’ records to eCIB on a monthly basis, and the information is only available to member banks and not to the general public. The eCIB report contains information such as your existing loan amounts, the start and maturity dates of any loans, your monthly instalments and any missed or late payments.
Using the information from the report, banks calculate a key metric – your debt burden ratio (DBR). This is simply the ratio of your income being spent on paying off the debt you currently owe. Let’s say you have a loan for which your monthly payment is Rs. 10,000 and your monthly income is Rs. 50,000. This means your DBR is 20%, i.e. 20% of your income is being spent on servicing your current debt. This ratio is not the sole determining factor of whether your loan is approved or not, but an important one. It should be equally important to you regardless of whether you are applying for a loan or not, in the interest of better financial planning. The State Bank has set a maximum DBR limit of 50% for all individuals. This means banks cannot provide any credit facility to a customer which would put his or her DBR over 50%.
Banks will take other factors into consideration such as the number of dependents, your nature of work, the amount of time you have been working with a particular employer (if you are a salaried individual) or your past business records if you are self-employed. So, having a high DBR does not necessarily mean you will be unable to obtain a loan; although if you are in such a position, taking on further debt is most probably not the best idea.
As a general guideline for budget management, most personal finance experts would suggest the 50/30/20 model. 50% of your take-home income should be reserved for your necessary expenditures, such as rent, utilities, food, transport, etc. The next 30% should be allocated to “wants” such as eating out and other forms of entertainment. The remaining 20% is the minimum one should save. If you have a relatively simpler lifestyle, meaning you do not eat out as much or go on many vacations, it would allow you to either save a little more or perhaps stretch the initial 50% on necessities. Limiting such expenses to 50% is a challenge for most people, especially if you have several dependents or if you are renting your accommodation or have a mortgage. It is important to assess and manage each type of expense individually. Rent/mortgage payments should be capped at 25-30% to provide you with enough flexibility with the rest of your necessities. I’ve discussed in an earlier post about auto loans and how those should be kept around the 10-15% mark as well.
Overspending on these necessities is what mainly leads to people racking up credit card debt, which is the ultimate killer for any budget, thanks to the exorbitant interest rates. I’ll go into more details on how to manage credit cards in a later post – but I have learnt that for most people, especially the younger generation, it is often best to avoid them completely.
Coming back to DBR – there are different ways keep it under check. If you are part of a dual income household, clubbing your spouse’s income with yours is allowed if you are applying for a facility jointly. This will improve your DBR and chances of getting a loan approved, provided that your spouse does not have a high amount of debt on his/her account too. Opting for longer tenure loans decreases your monthly instalments and will improve your DBR, but you should be careful because you will end up paying a lot more interest. However, these methods only improve the outlook cosmetically. It is better to try and reduce your outstanding liabilities before you approach a bank for another loan. See if you can make a balloon payment to close a current loan before you take on the next.
If you are a salaried individual, it is worth checking with your employer to see if they have any existing relationships with a bank that can provide you with better rates. A lesser interest rate will, of course, increase your chances of obtaining a facility. Lastly, it is important to keep in mind that every time a financial institution runs a credit check on you, your credit score goes down. It indicates that you are in constant need of credit and may be a high-risk borrower, reducing your chances of getting approved. You should only apply for a loan or credit card when you really need one.
Control your budget, do not let debt control it for you.