Can Fixed Obligations to Income Ratio (FOIR) affect your loan application?

Banks or NBFCs focus on a variety of aspects before approving a loan application. One of the common factors that affect a borrower’s application is the Fixed Obligations to Income Ratio (FOIR). Simply put, FOIR is your loan to income ratio. It reflects your actual disposable income and repayment capacity. It comprises your credit repayments per month, including all currently ongoing secured and unsecured loans, credit card dues, and any future loans you have currently applied for, as well as other recurring living expenses such as your house rent.

“The term FOIR refers to the proportion of one’s monthly income used for meeting unavoidable monthly expenses or obligations. Lenders use this ratio to evaluate the EMI affordability of the loan applicant. Those having lower FOIR are considered to have lower chances of defaulting on loan repayment. Hence, lenders prefer lending to applicants having lower FOIR,” said Gaurav Aggarwal, senior director at Paisabazaar.com.

Impact of FOIR on loan eligibility

Many lenders also use the EMI/NMI (Net Monthly Income) or EMI/GMI (Gross Monthly Income) ratios for evaluating applicant’s repayment capacity, preferring loan applicants having these ratios within 50-60% level.

“Ideally, one’s FOIR should not cross a certain threshold of your income. Usually, this is 50% but can vary depending on the income and other factors. If your FOIR goes above this threshold, the lenders might not approve your loan,” pointed Adhil Shetty, CEO at BankBazaar.com.

FOIR calculation

FOIR = Total monthly debt/monthly salary x 100

For example, if your current salary is Rs 20,000 and you apply for a loan of Rs 1 lakh with EMI of Rs 8,000, the FOIR/debt to income ratio will be – 8,000/20,000 x 100 = 40%

How to reduce FOIR?

Lenders consider EMI obligation of the new loan while calculating FOIR, EMI/NMI or EMI/GMI ratios. Hence, Aggarwal suggests, “Those exceeding 50-60% mark should try to reduce it by either prepaying or foreclosing some of the existing loans. Such loan applicants can make a higher down payment or margin contributions or opt for a longer tenure for the new loans to bring down these ratios within 50-60%.”

Since the FOIR is used to assess whether to approve a potential loan application or not, a reduced FOIR would imply that an applicant’s monthly financial obligations are considerably lower than their income. This reflects the applicant’s healthy repayment ability. Hence, lower FOIR increases the probability for quick loan approval as it indicates the applicant’s limited debt obligations.

“If your fixed obligation to income ratio is low, that is, if the amount you need to repay as EMI every month is a small percentage of your loan, you can get a higher loan. For example, if your net salary per month is Rs 80,000, your loan eligibility would be approx. Rs 38 lakhs with an EMI of Rs 33,000 per month for a 20-year loan,” Shetty explained.

This would mean close to 40% of your salary will go into servicing your loan. Banks typically fix the FOIR as 50%. Now, say you have an ongoing car loan of Rs 4 lakh at 12%, and an approx. EMI of Rs 9000. So, in all, you will be spending Rs 42,000 on EMIs. But this is more than 50% of your income, so the bank may not be willing to lend the entire Rs 38 lakhs.

In this case, Shetty stated, “You have two ways to increase the amount of loan you can borrow. You can enhance your eligibility by making your earning spouse/parents to join you as a co-borrower. This means that the net income of the borrowers goes up, and the eligibility increases. The other alternative is to opt for a longer tenor. If the tenor is increased to 25 years in the earlier example, the EMI will come down to Rs 30,500 thereabouts.”

Impact of credit utilisation ratio on FOIR?

The Credit Utilization Ratio (CUR) refers to the proportion of the total credit card limit used by you.

As per Aggarwal, “Lenders usually consider those with a CUR of within 30% to be financially disciplined. Those exceeding this set limit are usually viewed as credit hungry by lenders and hence, credit bureaus also reduce the credit score of the ones exceeding this 30% level.”

A reduced credit score would then adversely impact the concerned consumer’s loan and credit card eligibility.