15 January 2020
For lenders, loans can often be a risky affair. There is never a surety that the money lent will always be paid back. Now imagine the kind of risk that a bank or NBFCs hold, the primary part of whose business is lending money to corporates and individuals. Their responsibilities increase manifold, as the money is lent from the deposits that are made by the public. And a lot of times, even after proper checks and guarantees, banks end up with NPAs or non-performing assets.
Not surprisingly then, every bank follows certain criterion to determine whether or not an individual is eligible to get a loan. One such ratio that banks use it called FOIR, or Fixed Income to Obligation Ratio.
Fixed Income to Obligation Ratio is used by banks to determine the repaying capacity of a person. Banks consider the instalments of all the previous loans that are taken by an individual and their daily living expenses. By determining the total existing liability and expenses, banks can easily identify the disposable income that will remain with a person and whether or not they will be able to pay another loan’s instalment.
This metric is also known as the debt-to-income ratio. Statutory deductions such as taxes, PF, or insurance are not taken into account while calculating FOIR.
FOIR can be critical for determining eligibility criteria. If a person’s FOIR doesn’t match the standard set by a bank, it may lead to rejection of the loan, or they may not get the complete amount they need. Even if a person has paid EMIs of all the previous loans on time, this doesn’t necessarily mean that they will get further approved for a loan, if their FOIR is high.
FOIR can help bank easily gauge whether an individual will be able to pay the EMI of the prospective loan with all the expenses they have. And thus, they can decide whether or not to approve the loan to minimise any chance of loss.
Since the FOIR takes into account the expenses and liabilities with a proportion to the income of the individual, it can be applied to all applicants with different levels of income.
There is a simple formula to calculate FOIR.
FOIR = Debt+ Living expensesNet monthly salary100
Let’s understand this by an example.
The salary (in-hand) of Mr X is 50,000 per month. His monthly living expenditure (such as rent etc.) amounts to 20,000 and he already pays an EMI of 5,000 per month for his car loan.
Calculating using the above formula, his FOIR will be 50%. Thus, the person will be able to repay any loan whose EMI is less than 50% of his salary, or less than 25,000.
A person’s loan eligibility highly depends on their FOIR. The standard FOIR for any loan eligibility ranges from 40% to 60%. It can vary depending upon the level of income since we can’t compare FOIR of a person with income of 50,000 and that of 1,00,000.
The lower the FOIR, the better. This means that there are fewer expenses and the person is left with higher disposable income and a greater chance of paying the EMIs.
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