How Much Should You Borrow? Calculating the Right Loan Amount

Ravi wants to take a ₹5 lakh personal loan to renovate his house. He earns ₹50,000 a month and has ₹10,000 in monthly expenses. Ravi wonders if he can comfortably manage the loan. Let’s break it down.

If the loan comes with an interest rate of 12% for 5 years, his monthly EMI would be around ₹11,122. With his expenses and EMI, he’s left with ₹28,878 monthly. Sounds manageable, right? But what if an emergency arises? 

Studies show that around 40% of Indian households do not have adequate emergency savings, which could turn an unforeseen event into a financial struggle. That’s why calculating the right loan amount is so crucial.

Why Is It Crucial to Calculate the Right Loan Amount?

Borrowing is easy, but repaying isn’t always smooth. Here’s why you must think before you leap:

• Borrowing more than you need leads to unnecessary EMIs.
• Falling behind on repayments can hurt your credit score.
• Under-borrowing might force you to rely on costlier alternatives like credit cards.

Ask yourself these questions:

• Do I really need this loan?
• Can I afford the monthly EMIs?
• What happens if my income reduces unexpectedly?

Let’s say Ravi had borrowed ₹7 lakh instead of ₹5 lakh. His EMI would jump to ₹15,571. With the same income, he’d struggle to save anything. Calculating carefully can save you from such situations.

Factors to Consider When Deciding How Much to Borrow

Here’s what you should consider before applying for a ₹5 lakh personal loan or any loan:

1. Monthly Income and DTI Ratio

Your debt-to-income (DTI) ratio should ideally stay below 36%. For example:

• Monthly income: ₹50,000
• Existing debt: ₹5,000
• Maximum EMI you can afford (36% of ₹50,000): ₹18,000

This means a ₹5 lakh loan with ₹11,122 EMI fits well, but ₹7 lakh EMI doesn’t.

2. Loan Tenure

A longer tenure reduces EMI but increases overall interest.

Choose tenure carefully to strike a balance between EMI and interest.

Common Mistakes to Avoid

• Borrowing to the limit: Just because you qualify for a ₹5 lakh personal loan doesn’t mean you need it.
• Ignoring additional costs: Processing fees, insurance premiums, and late payment charges add up.
• No emergency buffer: Always keep 3-6 months of expenses as savings before taking a loan.

Other mistakes:

• Skipping loan comparison.
• Choosing longer tenure without calculating interest costs.
• Forgetting to account for income fluctuations.

Practical Tips for Smarter Borrowing

Follow these simple but powerful steps to borrow wisely:

• Compare loans from multiple lenders: Banks, NBFCs, and digital lenders offer varying interest rates.
• Use loan calculators: Estimate EMI and interest before applying.
• Borrow only what you need: If ₹4 lakh is enough, avoid ₹5 lakh.
• Aim for prepayments: Reduce interest costs by prepaying when possible.
• Keep EMIs manageable: Ensure EMIs are less than 30% of your income.

For example, if you have an annual bonus, you can use it for partial loan repayment to save on interest.

Conclusion 

Borrowing is a tool, not a trap. With thoughtful calculations and smart planning, a ₹5 lakh personal loan can fit seamlessly into your financial goals. 

But always remember—don’t just borrow because you can. Borrow because you need to, and only as much as you can repay comfortably.

Have you done your calculations yet?

FAQs

1. How much can I borrow if I earn ₹40,000 monthly?
   Around ₹6 lakh if your EMI doesn’t exceed ₹14,400.
2. What’s the best tenure for a personal loan?
   Choose shorter tenures to save on interest, but ensure EMI fits your budget.
3. Can I prepay my personal loan?
   Yes, most lenders allow prepayment with a nominal fee.
4. What happens if I miss an EMI?
   You’ll incur penalties, and your credit score will drop.