What is FOIR and Why Should You Understand it Before Taking a Loan?
Last Updated : July 22, 2020, 11:44 a.m.
A loan helps individuals in fulfilling their different financial needs. Be it buying a house, car, the latest smartphone in the market or any other thing, the answer to any need for funds is a loan if you don’t have sufficient savings with you. But when you apply for any kind of loan (personal loan, home loan, car loan, etc.), your repayment capacity is the first and foremost thing that a lender checks before providing you the loan amount. But why do lenders check your repayment capacity? What is the connection of FOIR with repayment capacity? Well, lenders want to ensure that a borrower can repay the loan amount within a fixed tenure in Equated Monthly Installments (EMIs), that’s why they check your repayment capacity.
Lenders use Fixed Obligations to Income Ratio (FOIR) to estimate your repayment capability. The ratio tells the proportion of EMI to your income. In case the EMI constitutes more of your income, the lender will most likely reject your application or disburse you less. Because the lenders feel at risk while lending you in such cases. We will cover all about the FOIR, its calculation, how does it affect your loan eligibility, and many other things in this article. So, keep reading!
Let’s Understand the FOIR in Detail!
Each lender likes to check the loan eligibility of applicants through Fixed Obligation to Income Ratio (FOIR). First, let’s understand what exactly FOIR is. As you can see clearly from its name, the FOIR is an individual’s income to debt ratio. Fixed obligations denote the overall debt that an individual has at a point in his or her financial life. While calculating the FOIR, the lender takes all the fixed obligations that an applicant has to meet on time every month. These fixed obligations can be Loan EMIs or Credit Card EMIs that you are currently paying.
The lender then considers your monthly income and calculates your FOIR. There is one thing you need to remember that Fixed Obligations also consider the EMI of the loan that you are applying for. Usually, lenders demand that an individual should restrict all his or her fixed obligations, including the currently applying loan EMI, to 50% or less of his/her monthly income. Simply put, a borrower should not be spending more than 50% of his monthly income on the Credit Card or Loan EMIs. Also, FOIR tends to change from one lender to another for different individuals, so you should check with the lender before applying for a loan. For example, the FOIR criteria can differ for a person earning INR 1 lakh per month as compared to a person earning INR 20,000 per month.
Let’s understand this through an example. Say an individual, Ved Sahni who is earning INR 40,000 per month. While he is paying EMI for different loans; INR 10,000 for Home Loan, INR 5,000 for Car Loan, and INR 6,000 for his credit card EMI. So, the sum of all his fixed obligations is INR 21,000 which is clearly more than 50% of his monthly income. Based on this, he may not be able to get any kind of loan.
What is the FOIR Calculation Method?
After knowing about the FOIR, you must be thinking about how lenders calculate the FOIR? Well, to calculate the FOIR, lenders use basic formulae that we are shown below. Have a look!
FOIR calculation= [Sum of Existing Fixed Obligations /Monthly Income] X 100
So, let’s find the FOIR for the Ved Sahni that we have taken as an example in the previous section.
Sum of All Fixed Monthly Obligation of Ved = INR 21,000
Ved’s Monthly Income = INR 40,000
So his FOIR will be = 21,000/40,000 X 100
= 52.50%
So, you can see that the FOIR of Ved is clearly more than 50% that will reduce the chances of him getting any kind of loan. Higher FOIR decreases an individual’s repayment capacity that’s why lenders check this parameter to decide the eligibility of an applicant. A lender does not want to provide a loan to an individual who has a higher number of existing obligations.
Impact of FOIR on Your Loan Eligibility
Before opting for any kind of loan, it is quite important to know how does FOIR affect your loan eligibility. There are a lot of people who face rejections from the lender because they don’t keep their FOIR in mind. When an individual has a higher FOIR, it simply means that an individual has many existing obligations. This factor can go against him or her while taking a loan from a lender. On the other hand, a lower FOIR means an individual has fewer existing obligations(Loan or credit card EMIs), leading to better repayment capacity and higher chances of approval, etc. We are telling you about all of them in detail.
Fewer Existing Obligations
You can only have a high FOIR if you have fewer existing obligations as you saw in the example also. To have a high FOIR, always opt for the loan according to your repayment capacity and within your monthly income. Like if you choose a higher loan amount, you will need to pay a higher EMI amount. And if this amount doesn’t suit your monthly income, your FOIR can be high. Or clear all the existing dues before opting for a new loan so that your FOIR remains within the eligibility criteria set by the lender.
Improved Repayment Capacity
Having a lower FOIR also enhances your repaying capacity. Let’s understand this in simple terms. Suppose your monthly income is INR 50,000 and you don’t have any existing monthly installments to pay. So, you automatically have a large portion of your monthly income from which you can pay your installments. This is known as Higher Disposable Income. A lender will always prefer to provide the loan amount to an individual with a lower FOIR as compared to an individual with high FOIR. You can also get a higher loan amount if you have a lower FOIR.
Greater Chances of Loan Approval
Having a lower FOIR also increases your chances of getting loan approval from the lender. Lenders like to provide a loan to people who have fewer existing obligations. But you should remember that this is only an aspect of eligibility criteria set by the lender. Other than this, you will need to meet other conditions set by the lender to get the loan amount. Like an individual with low FOIR and high credit score has higher chances for loan approval as compared to an individual with low FOIR but with a low credit score.