All financial institutions including banks have an array of very stringent eligibility criteria before sanctioning a loan. When a person is applying for a personal loan or any other loan facility, he or she has to go through a rigorous amount of multifaceted checks before the loan is finally disbursed. This is due to the fact that the possibility of repayment of a loan is an important measure that determines whether an individual is eligible for the loan or not. If this parameter is not validated, there are chances that the bank might incur losses due to non-repayment of the loan offered to a candidate attributing to non-performing assets or bad debts. In order to avoid such conundrum, financial organisations perform through background checks on the applicant including his or her income documents, credit repayment history, assets, financial liabilities, and other components that can affect the loan repayment ability of the individual.
There are 3 deciding factors or ratios that the banks calculate using the net income of a person to determine his or her eligibility for a loan:
While there are multiple parameters that are taken into account by a bank before approving a personal loan and various banks have different set of eligibility criteria, the most crucial one is the loan repayment ability of an individual. In order to ensure that the loan paid back, the bank carefully considers the following parameters of an applicant:
Fixed Obligations to Income Ratio (FOIR) is the parameter used by banks and other financial organisations to determine the eligibility for a loan of an individual. The FOIR of a person is derived by taking into account all the fixed monthly obligations that he or she should meet without including the statutory deductions such as Provident Fund, Investment Deductions, or Professional Tax. While additional expenses such as rent can also be considered as fixed obligation depending on the level of income, the FOIR reflects the disposable income of a candidate that can be used to pay off his or her debts - existing and new. Therefore, the loan eligibility of an individual highly depends on his or her FOIR.
The formula for calculating the FOIR of a person is given below:
FOIR = (Summation of All Existing Obligations/Net Monthly Salary) * 100
If the Fixed Obligations to Income Ratio of an individual is 50%, it means that a maximum of 50% of the monthly income of the person is assumed to be his or her living expenditure before the bank disburses a personal loan, home loan, car loan, etc. Therefore, the remaining amount of the income will be considered by the bank in order to determine the loan amount that the individual should be eligible for.
This can be explained further with the following example:
A person has a monthly income of Rs.50,000. Considering 50% as fixed obligations, the individual can pay up to Rs.25,000 towards his or her debts. If he or she has 2 existing loans with EMIs of Rs. 5,000 and Rs.6,000 respectively, the candidate is currently paying a total EMI of Rs.11,000. Therefore, the disposable income for the person is Rs.14,000. If this individual applies for a personal loan, he or she will be able to avail a maximum loan amount subject to the remaining monthly disposable amount, i.e. Rs.14,000.
A candidate with low FOIR is desirable while applying for a personal or any other type of loan. This is due to the fact that when a person has a high Fixed Obligations to Income Ratio, he or she has less amount of funds left as disposable income after paying the existing EMIs. If this person is disbursed another loan, there are high chances that he or she will not be able to pay the EMI for repayment of the new loan. Thus, this will lead to high credit risk and the chances of banks denying a loan application will also be higher.
While the margin for Fixed Obligations to Income Ratio differs from lender to lender and varies in each scenario, the required FOIR of an individual for loan eligibility for most of the banks ranges from 40% to 60%. However, this can go up to 65% to 70% for a customer with an extremely high net worth.
If you are worried about your loan approval since your Fixed Obligations to Income Ratio is higher than the concerned bank’s margin then you can apply for a loan with another working candidate. In that scenario, the burden of the payment of EMI will be divided. For instance, a married working couple can easily share the monthly payments, thus, will have better chances of loan approval if they opt to avail a loan jointly.