What is FOIR? Impact on Home Loan Eligibility in India

In the journey to owning a dream home, securing a home loan is a critical step for many Indians. This process involves a careful scrutiny of the borrower’s financial health. Where banks employ various metrics to ensure that the individual can sustainably shoulder the new debt. Among these metrics, the Fixed Obligation to Income Ratio (FOIR) plays a pivotal role. Acting as a gauge for potential lenders to measure financial prudence and stability of applicants.

This blog aims to shed light on how FOIR influences the approval, conditions, and. Experience of obtaining a home loan in India. By exploring its impact, we will uncover insights. That help prospective borrowers navigate their path to securing financing for their homes more effectively. 

What is FOIR? Understanding the Basics

Banks and lending financial institutions use the Fixed Obligation to Income Ratio (FOIR), a financial metric, to assess a borrower’s ability to take on and manage additional debt. The Fixed Obligation to Income Ratio calculates the percentage of an individual’s gross monthly income that existing loans, rent, and other recurring monthly debts already commit.

Components in FOIR

1. Total Fixed Obligations: This component aggregates all the monthly financial commitments that a borrower must pay. It includes:

• Monthly payments on existing loans (home loans, auto loans, personal loans, etc.)
• Minimum monthly payments on credit card balances
• Other recurring financial obligations, such as alimony or child support payments, and rental payments if applicable.

2. Gross Monthly Income: The total monthly income the borrower earns before any deductions like taxes, contributions to retirement funds, and other withholdings is this component. It encompasses:

• Salary 
• Bonuses and overtime payments
• Other consistent sources of income such as rental income, dividends, or income from investments that can be verified and considered reliable

How to Calculate FOIR?

The ideal FOIR ratio typically ranges from 40% to 55%. This range is considered favourable as it suggests that the borrower has a balanced amount of their income free for future obligations and living expenses after accounting for their current debts. T

he formula for FOIR is as follows:

FOIR = Total Fixed Obligations/ Gross Monthly Income × 100

Note:

• A lower FOIR suggests that a borrower has a greater portion of their income available for new loans, making them a lower-risk candidate for lenders. 
• Conversely, a high FOIR might indicate financial strain or limited capacity to take on additional debt, influencing the lender’s decision on the loan application, including potential rejection or adjustment of loan conditions.

How Does a Bank or an NBFC (Non Banking Financial Institution) Use FOIR?

1. FOIR is utilised by banks and NBFCs to determine a borrower’s capacity to manage loan repayments after covering existing fixed obligations like other loan EMIs and rent.
2. They typically maintain a maximum FOIR limit between 40-55%, used to assess whether a borrower has sufficient disposable income to handle new loan repayments.
3. A high FOIR indicates a higher potential for repayment stress and could signal a risk of default, influencing the bank’s lending decision.
4. Depending on the FOIR, banks might modify the loan amount or its interest rate terms to ensure the borrower isn’t financially overstretched.
5. FOIR is critical in setting underwriting policies for banks, affecting their risk tolerance and adapting to market conditions and borrower profiles.

The Inverse Relationship Between FOIR and Home Loan Amounts

The Fixed Obligation to Income Ratio (FOIR) and the home loan amount typically share an inverse relationship. Essentially, as the FOIR increases—indicating that a higher percentage of a borrower’s income is committed to repaying existing debts—lenders perceive a greater risk of default. This perception leads banks to offer lower loan amounts to ensure that the borrower isn’t overburdened with debts and can manage new loan repayments comfortably. 

A lower FOIR, conversely, suggests that a borrower has more disposable income available, thereby qualifying them for a larger home loan. This dynamic is crucial for lenders and borrowers alike, as it helps maintain financial stability and ensures that loans are issued within safe financial bounds.

Factors Affecting the FOIR Ratio

1. Income Level: The borrower’s gross monthly income is a primary factor. Higher income can potentially lead to a lower FOIR, assuming fixed obligations remain constant, thereby increasing loan eligibility.
2. Existing Debts: The total amount of existing monthly debt obligations, including EMIs for loans, credit card payments, and any other fixed financial commitments, directly increase the FOIR. More debts lead to a higher FOIR.
3. Interest Rates: Changes in interest rates can affect the EMI amounts for variable rate loans, thereby affecting the FOIR. 
4. Loan Tenure: The duration of existing loans also impacts FOIR. Longer tenures generally result in lower EMIs, which can reduce the FOIR, making room for additional borrowing.
5. Household Expenses: Recurring non-debt obligations such as rent and utility bills are included in the FOIR calculation. Higher or additional commitments can raise the FOIR.
6. Employment Stability: Job security and the nature of the borrower’s employment (e.g., salaried vs. self-employed) can influence lenders’ assessment of income stability, indirectly affecting FOIR calculations by impacting perceived income continuity.

Tips and Tricks to Maintain a Healthy FOIR

• Reduce Debt: Paying down existing debts such as loans and credit card balances can decrease your fixed monthly obligations, thereby lowering your FOIR. Consider using any surplus income or savings to pay off debts earlier.
• Manage New Debt: Be cautious when taking on new debt. Before acquiring more debt, assess its necessity and impact on your FOIR. Opt for fewer and smaller loans whenever possible.
• Refinance Existing Loans: If you have high-interest loans or loans with significant monthly payments, consider refinancing to secure lower interest rates or longer repayment terms. This can reduce your monthly obligations and improve your FOIR.
• Budget Wisely: Create and adhere to a budget that prioritises essential expenses and debt repayments over discretionary spending. This discipline helps manage cash flow and prevents increases in fixed obligations.
• Monitor Your Financial Obligations: Regularly review your financial commitments to ensure they remain manageable relative to your income. This includes not just loans but also recurring expenses like rent and utilities.
• Plan for Large Expenses: If you anticipate large expenses (like education fees or home renovations), plan for them by saving in advance or exploring financing options that won’t significantly disrupt your FOIR.

Key Points to Remember

• Fixed Obligation to Income Ratio measures the percentage of a borrower’s gross monthly income that goes towards paying existing fixed obligations like loans and rent.
• Higher FOIR leads to lower loan eligibility as more income is already tied up in debt, increasing the perceived risk for lenders.
• A FOIR between 40% to 55% is generally favourable, indicating a healthy balance of debt and disposable income.
• Lower FOIR can result in better loan terms, including lower interest rates and potentially larger loan amounts.
• Lenders use FOIR to assess a borrower’s ability to take on new debt without financial strain.
• Reducing debt, managing new debt intake carefully, refinancing existing loans, and budgeting wisely can help maintain a lower FOIR.

Frequently Asked Questions [FAQs]