What is FOIR? How does it impact personal loan approval?

The FOIR, which is an important financial yardstick, measures your ability to manage existing debts alongside your new loan repayments. It measures whether your income can support another interest payment over time.

In this article, we’re going to understand the FOIR better, figure out why it matters, and how you can improve it to get approved for a personal loan.

Understanding FOIR in-depth

FOIR, simply put, measures the percentage of your monthly income committed to existing fixed obligations. These encompass recurring expenses like:

• Existing loan EMIs: Home loans, car loans, personal loans, etc.
• Credit card minimum payments: Monthly minimum required towards outstanding credit card dues.
• Rent or rent equivalent: The rent you pay or an estimated equivalent for homeowners.
• Other fixed commitments: Maintenance charges, insurance premiums, etc.

By figuring out the amount of money you have to pay towards your liabilities every month no matter what, creditors can assess whether you have the financial ability to pay an added interest from another loan. Typically, banks have to be pretty sure of how much more you can cover before they issue another loan to you.

Calculating the FOIR

Here’s how you can calculate your own FOIR on paper:

FOIR = (Total Monthly Fixed Obligations / Gross Monthly Income) * 100

For example, let’s assume your monthly income is ₹50,000 and your fixed obligations total ₹20,000 (including existing loan EMIs, rent, and credit card minimum payments).

FOIR = (20,000 / 50,000) * 100 = 40%

In this scenario, your FOIR of 40% falls within the ideal range, increasing your chances of securing a personal loan with favourable terms.

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The effect of FOIR on personal loan approval

Lenders in India are sensitive to the FOIR when lending money, especially personal loans where the risk of defaulting is higher. If you have a low FOIR, it signals to the bank that your income might not sustain enough funds for managing new debt, which makes you an unattractive borrower. On the other hand, if you have a large portion of your income that’s discretionary, you are a safer bet from the bank’s perspective.

Here’s a general guideline for FOIR for you if you’re considering applying for a personal loan:

• Ideal: 40-55% – Indicates that your debt obligations are pretty manageable. Having an FOIR around this range increases your chances of getting your loan approved.
• Moderate: 55-70% – May require scrutiny from lenders and potentially affect loan terms.
• High: Above 70% – Significantly reduces loan approval probability because lenders don’t think you’ll be able to pay back the loan reliably.

Understand that these are indicative ranges and that different banks might have different ranges themselves depending on who they lend to, prevailing interest rates, and your financial situation. Other metrics like credit score, employment stability, and income sources other than salary may also be considered.

Also Read: The role of compound interest to reach your financial goals

Improving your FOIR

If you don’t have the ideal FOIR and you want to maximise your chances of getting approved for a personal loan, here are some things you can do to improve that ratio:

• Reduce your debt: Pay off high-interest debt or consolidate loans to decrease monthly obligations.
• Increase your income: Explore income-generating opportunities to raise your overall monthly income.
• Negotiate the terms of existing loans: Talk to existing lenders about restructuring loans for lower EMIs which could reduce the amount of money you pay every month.
• Minimise variable expense: Cut back on non-essential spending to free up more income for debt management. This increases your discretionary income and signals to the lender that you have more money to pay towards servicing the new loan.

Also Read: Mastering the maze: Your pathway out of student loan debt

Conclusion

Apart from being just another metric that banks care about before issuing you a loan, the FOIR is also a good means for you to assess your own financial health. For instance, the FOIR can:

• Help you understand your debt better: By calculating the FOIR, you understand how much of your monthly salary goes towards servicing the interest on your debt, making you more conscious about how much you can actually spend.
• Planning for the future: If you plan to save money for retirement or your education, you might want to lower your FOIR so that all your money is not spent paying interest to banks.
• Negotiate better interest rates: Having a high FOIR can also motivate you to negotiate your interest rates, which could be helpful to you in the long-run.