When you apply for a home loan, your loan repayment ability goes under the scanner, since it is the most critical factor that lenders consider first. Banks and financial institutions follow stringent eligibility criteria while screening a home loan application. Before sanctioning a loan, they ensure that the applicant is not a credit risk and can repay the borrowed sum through timely Equated Monthly Instalments (EMI).
Lenders look up your personal credit history, income documents, current assets, liabilities and other financial details. These background checks enable lenders to assess an applicant's creditworthiness and the risks involved in lending.
There are three deciding factors that lenders calculate using the net income of an applicant to determine home loan eligibility. These are:
Fixed obligation to income ratio (FOIR)
Loan-to-value ratio (LTV)
Instalment income ratio (IIR)
A fixed obligation to income ratio or FOIR is a popular parameter that lenders use to calculate home loan eligibility of applicants. It is also referred to as the debt to income ratio.
While calculating the FOIR, lenders consider the applicant's income and the instalments of all the loans that s/he is currently servicing. They also consider the projected EMIs of the home loan applied for. However, statutory deductions, such as provident fund, professional tax or those for investments like insurance premium, recurring deposits, etc., are not part of the fixed obligation category.
FOIR differs across lenders and can vary in every applicant's case. Usually, it is between 40% to 60% of the applicant's net per month income. However, it could be more depending on the lender's policy. A higher FOIR can be leveraged if you have no previous loan obligations, compared to those with running loans.
While providing any sort of relief in FOIR is solely at the lender's discretion, some financial institutions have relaxed norms to accommodate insurance premia. The FOIR in the case of some individuals, like self-employed applicants and professionals, may be high due to certain significant parameters.
Lenders use the following formula to calculate FOIR:
FOIR = Sum of all existing fixed obligations / Monthly income x 100
FOIR makes it easier for lenders to gauge the applicant's ability to repay a home loan. In this instance, since the FOIR is already over 50% of her current income; lenders might doubt her abilities in repaying the loan, keeping in mind her current liabilities. Therefore, her home loan application is likely to have lesser chances of an approval.
Before opting for a home loan, it is essential to understand how FOIR affects your loan eligibility. Many home loan applicants find it difficult to secure loan approvals because they don't understand the implications of their FOIR. If an individual has a higher FOIR, it simply means that s/he has some existing liabilities. While seeking home loans, this factor might work against him/her.
A lower FOIR is always preferred because it means the applicant has fewer liabilities, which denotes a better repayment capacity and, consequently, enhances his/her chances of getting a loan approval.
The impact of FOIR on one's loan eligibility can be observed in the following ways:
A high FOIR indicates existing liabilities. In order to reduce your FOIR, always opt for a home loan according to your repayment capacity and monthly income. If you choose a higher loan amount, your monthly instalments will also increase. And, if this sum does not align with your monthly income, your FOIR could shoot up. Moreover, it is always advisable to clear all existing credit before taking up a new home loan, so that your FOIR stays within the eligibility criteria set by the lender.
Having a low FOIR enhances your loan repaying capacity. If you don't have any existing debts, you can divert a larger portion of your monthly income towards repaying the loan EMIs. This means that you have a higher disposable income. A lender will always favour loan approvals for applicants with a lower FOIR as compared to those with a high FOIR. If you have a reduced FOIR, you can easily avail a higher loan amount.
Having a lower FOIR increases your chances of getting a loan approval. Lenders prefer to extend home loans to applicants who have fewer existing obligations. Apart from this, you will need to meet other eligibility conditions fixed by the lender to avail of the desired loan amount.
If you have a high FOIR, you can apply for a home loan along with a co-applicant to ensure greater chances of securing a loan approval. Remember, the co-applicant should be an earning family member such as your spouse, parent or sibling.
When you apply for a home loan, lenders request an inquiry from the credit bureau. These inquiries are registered and later reflect in your credit report, thereby affecting your credit score. If there are multiple inquiries, it lowers your credit score. Hence, it is recommended that you calculate your FOIR before applying for a home loan. A combination of low FOIR and high credit score enhances your chances of getting loan approval, and also, helps to negotiate better terms with the lender at lower rates of interest.
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