If you fancy making asset purchases on credit, you would want to be aware how much loan amount you can get. I am not talking about minor purchases where you can simply swipe your credit card. Once the credit card is approved, you can use your card, subject to credit limit, wherever you want. The bank does not have to sanction a loan for every purchase. I am talking about big ticket items where you can’t use your credit card and the bank has to formally sanction you a loan. The examples would be a personal loan, car loan or even a home loan. You do realize that you can’t get unlimited amount of loan. The amount of loan that you can get depends on your repayment ability. And the banks try to assess your repayment ability before giving you a loan.
Fixed Obligations to Income Ratio (FOIR)
Banks use FOIR (Fixed Obligations to Income Ratio) as one of the parameters to arrive at your loan eligibility. The idea is that your existing loan EMI obligations (along with loan EMI under consideration) should not exceed a particular threshold. If the bank considers other fixed obligations such as rent too, you can expect the threshold FOIR to be slightly higher. Let’s not consider house rent in this post.
FOIR = Total EMI for existing and proposed loan ÷ Net income
Net income will be your in-hand income after statutory deductions and taxes.
How Banks Use FOIR?
Let’s try to understand this with the help of an example. Ashish earns Rs 50,000 (net) per month and pays an existing home loan EMI of Rs 10,000. He wants to apply for a personal loan. How much can he get? Let’s assume the bank will have a threshold FOIR of 50% for Ashish. This means that the bank will give Ashish the loan amount such that his total loan EMIs don’t exceed Rs 25,000 (50% of Rs 50,000). His existing EMI is Rs 10,000. Therefore, the additional EMI that Ashish can afford is Rs 15,000 (Rs 25,000 – Rs 10,000). With this number, you can work backwards to calculate the maximum loan amount. Of course, you need the rate of interest and loan tenure too. For an interest rate of 10% p.a. and loan tenure of 5 years, the maximum loan amount an EMI of Rs 15,000 can service is Rs 7.05 lacs.
Your loan eligibility will increase with:
- Increase in net income ↑
- Increase in threshold FOIR ↑
- Decrease in existing EMIs ↓
- Decrease in loan interest rate ↓
- Increase in loan tenure ↑
I have considered a few examples to demonstrate the impact of various parameters on your loan eligibility. I have used Microsoft Excel PV function to determine loan eligibility.
|S.No.||Net Income||Existing EMIs||Threshold FOIR||Maximum Total EMI||Additional EMI for new loan||Loan Interest Rate||Loan Tenure (months)||Loan Eligibility|
For a given EMI (that you can afford), rate of interest and loan tenure, you can determine how much loan you can afford using our Loan Calculator too. Various bank and NBFC website have their own calculators on the websites.
There Is No Standard Threshold FOIR
The threshold ratio may vary across banks and may not even be disclosed. As I understand, not many banks would be comfortable once the FOIR breaches 50%. However, it is possible that banks may make exceptions for very high income or high net worth individuals. And I can see reasons for the same.
Let’s consider an example. Ashish earns Rs 50,000 per month and Ramesh earns Rs 5 lacs per month. Neither has any loan. You can expect fixed expenses (say rent, groceries etc) to be a fairly high portion of Ashish’s monthly income. The same cannot be said for Ramesh. At such high level of income, he may be saving much more (in percentage terms). Therefore, it is possible that the bank may restrict Ashish to a FOIR of 40% while it may go up to 60% for Ramesh.
A similar argument can be extended to High Net-worth individuals. Note that this is a conjecture. Banks have different policies for determining loan eligibility.
Points to Note
- Fixed Obligations to Income ratio is not the only parameter looked at by banks to arrive at your loan eligibility.
- Banks look at your credit score, loan-to-value ratio (LTV) and many other parameters (say employment, age etc).
- A low credit score may make FOIR irrelevant. If you don’t make the cut-off credit score, your income or FOIR may not matter.
- Banks won’t fund more than a certain percentage of your purchase price (as per LTV).
What to Do If I Have a High FOIR?
Well, there is not much you can do. One way is to close some of the existing loans. I understand that this may not be an option. The other option is to have a joint applicant with you. With a joint applicant (who is working), the EMI burden gets divided and the loan eligibility may increase.
Banks will do what they want to do. However, they do not know as much about you as you do. Moreover, they don’t care much. If you don’t repay the loan, they will take away the asset. You need to be very clear where you are headed. For instance, if you foresee lack of stability in your job, you should refrain from increasing your loan liability. Now, the bank may not be aware of this uncertainty and be ready to give you the loan but you need to be responsible. I have covered such aspects in this post.