Multiple factors are crucial for evaluating a person’s financial situation in the vast universe of finances and banking. A good example of this statistic is FOIR. However, it is frequently lost amid abbreviations and banking terminologies. Let us clarify what it means, learn its entire expression in finance, comprehend the FOIR calculation technique, and find the total significance of this metric.
Around a decade or almost two ago, banking organizations focused on huge corporate finance loans for their businesses. However, numerous huge corporations have fallen apart, which has caused a massive NPA (non-performing assets) issue for banking institutions. It has prompted banks to concentrate on their retail customer base.
As a result, the retail industry finance portfolio, including housing loans and personal loans, has increased. Banking institutions have developed appealing offers for the retail market. Additionally, they simplified the eligibility requirements to appeal to a broader audience. The program covers both self-employed individuals and ordinary people.
What is Meant By Fixed Obligation to Income Ratio or FOIR?
FOIR is a common parameter used by banks to decide on applicants’ loan eligibility. This isn’t an entirely new notion; banks formerly used the term ‘net take-home pay’ to signify a comparable qualifying percentage. According to the FOIR principle, the bank looks into the outstanding installments of every single loan obtained by the borrower. It also takes into account the equated monthly installment (EMI) of the proposed loan under assessment.
FOIR includes all fixed commitments that an applicant is probably going to meet every month. It involves loan installments that are not covered by the salary, periodic credit card installments (EMIs), and other expenses. It excludes statutory deductions such as the Provident Fund, Professional Tax, insurance coverage, recurring savings accounts, and other such expenses.
A loan assists people with meeting their various financial obligations. Suppose you are unable to accumulate sufficient savings to invest in a house, a sedan, the most advanced smartphone on the market, or anything else. In that case, borrowing money is an option for your financial needs. However, whether you ask for any type of loan (personal loans, housing loans, auto loans, etc.), a lender will most definitely look at your ability to repay potential before granting you the funding sum.
Now, Why Would Financial Institutions Assess Your Ability to Repay?
What is the link between FOIR and reimbursement abilities? Financial institutions assess repayment abilities to ensure that customers can repay the loan over a set number of EMIs.
Standard FOIR
Banking institutions use specific FOIRs to issue various loans. That may be 50% for personal loans and 35 per cent to 40 per cent for a home loan. Typically, banking institutions fix the FOIR at 50%. Additionally, it is dependent on the borrower’s earning potential. That means you cannot compare somebody making Rs. 30,000 monthly to someone earning Rs. 200,000 monthly. Bankers are sufficiently flexible in this matter, adjusting the FOIR accordingly.
How Does the FOIR Get Calculated?
The FOIR is figured out by applying a simple formula:
FOIR = (Fixed Obligations / Gross Monthly Income) x 100.
Let Us Show How it Works:
Permanent responsibilities are all of your permanent money-related obligations, such as EMIs, insurance payments, and other recurring expenses. Gross income for the month is your entire monthly earnings just before any costs are deducted, such as pay or other earnings.
Multiplying the outcome by 100 turns the ratio into a percentage, indicating how much of your income is dedicated to fixed liabilities.
Let’s now explain the FOIR computation with an example. Assume you earn ₹60,000 per month and have ₹30,000 in fixed expenditures (e.g., loan EMIs, insurance payments). The FOIR will be calculated as (30,000/60,000) * 100 = 50%. It indicates that 40% of your earnings has been allocated for fixed liabilities.
Reversed Calculation
The primary goal of calculating the FOIR is to allow the bank to perform a reverse computation to evaluate eligibility for loans.
The scenario below should be clear:
Mr Arun earns Rs. 90,000 every month. He pays Rs. 8,000 in personal loan payments and Rs. 6,000 in automobile loan repayments right from his banking account. Let’s find the FOIR.
- 50% of 90,000 = 45,000
- Automobile loan EMI = Rs. 6,000
- Personal loan’s EMI: Rs. 8,000
- The amount that can be used for this loan is Rs. 31,000.
Thus, the banking institution can set up the loan criteria in such a way that the monthly installment amount cannot go over Rs. 31,000.
What is the Significance of the Above Illustration?
The instance shows that the prospective borrower is qualified for a home loan with a payback of up to Rs. 31,000. The Housing Loan Calculator makes calculations simple. It may also help you review different financial institutions and decide on the lender who offers the most loan possibilities.
One strategy to increase the eligibility for loans is to choose a longer term. Additionally, you can attempt to fully repay a personal loan or automobile loan, which will boost your repayment ability.
How Can the FOIR Have an Impact on Your Loan Acceptance?
The smaller your FOIR, the better your probability of acceptance. A low FOIR indicates that you’re carrying fewer obligations. It effectively raises the income that you can spend, which improves your repayment capacity.
The FOIR concept has allowed independent professionals and laypersons to receive loans from banking and non-banking financial institutions. This is more advantageous to this type of borrower because they lack a stable income. The banking sector was previously hesitant to credit this type of customer due to the disparity in financial status.
Why is it Important to Figure out FOIR?
Let’s look at a realistic circumstance to see how important the FOIR estimate is for taking out loans. Let’s say Rohit and Nikhil, two buddies, ask for an automobile loan independently. When Rohit applied, the financial institution checked his FOIR at 55%, whereas Nikhil’s was 70%. In this instance, the financial institution will choose to give Rahul the loan sum he requested.
Meanwhile, Nikhil may experience difficulties receiving a positive loan sanction because his profile shows a higher risk to the lenders. Therefore, having a smaller FOIR always improves the possibility of loan acceptance.
How Can the FOIR Increase the Probability of Your Loan Acceptance?
If you continue to retain a low FOIR, it affects your entire financial status.
- If Your entire liability gets lowered.
- The amount that can be used increases.
- Lenders become more confident in applicants’ repayment ability.
These things complement one another to increase your financial standing. Having a low FOIR will assist you in organizing your finances more effectively. This not only increases your average monthly disposable income but also lowers your total obligations and enhances your loan payback ability.
These elements are important when seeking personal loan confirmation because they indicate your ability to repay loans to lenders, increasing your likelihood of receiving prompt approval.
How to Reduce FOIR?
Here are some tried-and-true strategies for lowering your FOIR and increasing the probability of getting a loan approved:
- Pay off every remaining debt as fast as possible.
- For fresh loans, you can ask with a co-applicant as long as the second person in question has a low FOIR.
- Pay your bills on schedule and pay off your outstanding balances. This enables one to maintain a lower credit utilization ratio, which leads to a positive credit history. Productive behaviour like this can ultimately help maintain a decent FOIR.
- Financial institutions may regard frequent job changes as volatility in employment security. This may not function well when asking for a loan.
- Avoid taking out too many loans at one time. Complete the repayments one by one and then apply for a fresh loan.
- Look for financing options only if you meet the lender’s eligibility requirements.
- Present the financial institution with proof of steady earnings.
- In addition to maintaining a low FOIR, you must also have a good credit score to qualify for a suitable loan and prevent financial ruin.
What is An Appropriate FOIR to Have Around?
In the ideal scenario, FOIR should be 40% to 50%. So, your overall monthly costs should not be more than 50% of your profits. For those with a greater net worth, financial institutions regard even higher FOIRs (beyond 65% to 70%) as beneficial for loan transactions.
Do All Financial Institutions Have the Same FOIR Standards?
No, because financial institutions have not established a standard margin for FOIR. Yet, most NBFCs and banks regard a percentage of 40% to 55% as the most beneficial. However, the limit is not defined and is likely to vary depending on the loan category and the applicant’s financial position.
How Can Refer Loan Help You Get Approved for A Loan Seamlessly?
Refer Loan, a digital fintech platform can assist borrowers in calculating their FOIR and directing them to banking institutions with greater loan acceptance probabilities. You may use the EMI calculators on Refer Loan’s official portal to estimate how much you’ll pay in EMI and find out your loan eligibility.
Bottom Line
FOIR, or Fixed Obligation Income Ratio, is a significant indicator evaluated by financiers when issuing a loan. It shows what percentage of the individual’s earnings already go towards covering fixed obligations such as EMIs, the cost of rent, and living expenses. The greater the level of the ratio, the less likely you are to be able to repay any future loans. Maintain a FOIR of 40–55% to ensure a decent likelihood of being approved for a loan.
A low FOIR also improves your probability of receiving funding authorization from the lenders. Financial institutions prefer to make loans to people who have fewer existing debts. Keep in mind, however, that this constitutes only one component of the lender’s acceptance criterion. Aside from that, you must comply with the lender’s additional requirements to receive the loan amounts. For example, someone with a small FOIR and a good credit rating is more likely to be approved for a loan than someone with a low FOIR but a poor credit score.