There’s a misconception that personal loans are bad for you. They sink you further into debt, cheat you through sky-high interest rates, and do more harm than good for your finances. However, you can use personal loans to your advantage. They can cover unforeseen expenses, such as health bills and expensive home or car repairs and can be used to pay school-related expenses among others.

Just because personal loans can benefit you, it doesn’t mean that you should start taking them out. You can use personal loans during an emergency, but you must have a mindset of paying them back. If you forget these, then the misconception holds true – that loans can ruin your finances.

“You can use personal loans during an emergency, but you must have a mindset of paying them back… and use them only as a last recourse.”

In the event that you need to apply for a personal loan, here are 4 factors that affect your personal loan application.

Credit History

A credit history shows your discipline to handle credit. If you continually max out your limit, this may give the notion that you are dependent on credit, and you’ll be dependent on the personal loan you’re applying for. Having a positive credit history shows your ability to manage debt over a long time.

Employment and Income

Payment periods for personal loans can range from 6 to 36 months. Showing proof of employment, usually your pay slip and a Certificate of Employment, gives the bank security that you have income coming in on a bi-monthly basis to pay the loan. For self-employed individuals, you would need to submit other documents, such as audited financial statements and a business permit, when applying for the loan. As for your income, its importance is in the loan amount you’ll be able to borrow. If you have a higher income, you can avail of a larger loan amount. If you have a smaller income, you may not have the capacity to pay back higher loan amounts.

Showing proof of income and employment proves to the lending institution you have the capacity to pay the loan back. Keep in mind that the borrowers expect to get their money back and will reduce their risk as much as possible. One way to reduce risk is to lend to individuals who can pay the loan back.

Outstanding Debt

As lending institutions expect you to pay the loan back, they will only let you borrow the amount you can afford to pay back relative to your income. In the same way, your outstanding debt may decrease the loan amount you can borrow.  Banks factors in your debt-to-income ratio, which measures your ability to pay your total debt with your income. See below to calculate your debt-to-income ratio

(Debt 1 + Debt 2 + Debt 3…+ Debt N)/ Gross monthly income) = debt-to-income ratio

Ex:

(Php 1,500 + Php 1,000 + Php 5,000)/ Php 15,000 = 0.5

0.5 x 100 = 50%

Your debt-to-income ratio is 50%

In the example, a debt-to-income ratio of 50% is bad news because half of the gross monthly income just goes to debt. Before applying for a personal loan, make sure that your debt-to-income ratio is low to increase your chances of approval and avoid being charge a higher interest fee.

Payment History

Borrowers want to make sure that you will pay them back by prioritizing paying the loan you got from them. This includes car, and mortgage payments, student loans, credit card, and other loan types and the frequency in which you paid them. Late payments show that you may lack discipline to pay back loans. However, on-time and regular payments show that you’re responsible to pay back your loan which minimizes your risk to the borrower.

Now that you know which factors affect your personal loan application, you’re more ready for the application process. You know which documents to prepare and you have an idea of the direction of your loan approval. You can take your preparation a step further by researching on different personal loans from various providers through financial comparison websites. These comparison platforms, such as MoneyMax.ph, allows you to compare personal loans from various providers and filters your search results according to income, payment period, and interest rate among others.

Always treat any form of debt with much wisdom. “The only man who sticks closer to you in adversity than a friend is a creditor.”