IIR in banking most commonly refers to the Instalment Income Ratio.
The Instalment Income Ratio (IIR) is a financial metric used to assess a borrower's ability to manage debt repayments. It represents the proportion of a borrower's gross income that is dedicated to covering debt obligations, specifically those paid in installments.
Here's a breakdown of what it entails:
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Definition: IIR measures the percentage of a borrower's gross monthly income used to pay monthly installment debts. These debts typically include car loans, personal loans, student loans, and other similar obligations. It excludes mortgage payments, which are usually assessed separately using a different metric like the debt-to-income (DTI) ratio.
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Calculation: The formula for calculating IIR is as follows:
IIR = (Total Monthly Instalment Debt Payments / Gross Monthly Income) * 100 -
Significance: Banks and other lenders use IIR to evaluate the creditworthiness of loan applicants. A high IIR indicates that a significant portion of the borrower's income is already committed to debt payments, which may increase the risk of default. Conversely, a low IIR suggests that the borrower has sufficient income to comfortably handle additional debt.
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Acceptable Thresholds: While specific thresholds vary among lenders, a generally accepted IIR benchmark is below 20%. An IIR exceeding 25% might be considered high-risk, potentially leading to loan rejection or higher interest rates.
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Example: Consider a borrower with a gross monthly income of \$5,000 and total monthly installment debt payments of \$1,000. The IIR would be:
IIR = ($1,000 / $5,000) * 100 = 20%This IIR of 20% is generally considered acceptable.
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Relationship to Debt-to-Income (DTI) Ratio: While IIR focuses solely on installment debts, the Debt-to-Income (DTI) ratio is a broader measure that includes all monthly debt payments, including mortgage payments, in its calculation. Both ratios provide lenders with valuable insights into a borrower's financial health and ability to manage debt.
In summary, the Instalment Income Ratio (IIR) is a crucial tool for banks in assessing the creditworthiness of borrowers by evaluating their capacity to handle installment debt repayments.
