Home Loan Eligibility – How Banks Calculate Loan Eligibility Amount

In this blog post we are going to discuss three important parameters namely – Fixed Obligation to Income Ratio (FOIR), Loan to Value Ratio (LTV) and Installment Income Ratio (IIR), which are instrumental for deciding the home loan eligibility amount as calculated by different banks and financial institutions. We will also discuss about different parameters of your credit profile, which help the lenders to determine your home loan eligibility amount.

home-loan-eligibility-amountBanks and financial institutions help individuals fulfill their dreams of owning a home by extending loans and mortgages. But it is to be remembered that they are also commercial organisations and they are doing business for earning a profit for their shareholders. Before sanctioning a loan to a prospective borrower, every lender tries to ensure that the borrower has the capacity to pay the EMI installments in time and repay the principal.

For this purpose the first thing which every lender tries to ascertain is the loan eligibility amount for which you qualify depending upon your credit profile. Every bank in India has its own policy and standard for reviewing the loan application and to evaluate the home loan eligibility amount.

The Criteria Which Decide Your Repaying Capacity

Although every bank has its own policy and the standard for reviewing a loan application, but following is the list of the general criteria, used by almost all banks and financial institutions while reviewing a loan application.

  • Your monthly fixed and variable incomes – from different sources
  • Your present age
  • Your qualification
  • Your current employer (if you are a salaried employee) or the nature of your business (if you are self-employed)
  • Your job experience
  • Your tax payment history
  • Your outstanding loans and all the instalments you are required to pay on a regular basis
  • Your asset and liability statement
  • Tenure of your loan

This is not an exhaustive list and the bank may ask for any particular information depending upon your current situation and details given in the loan application.

Three Ratios, Which Determine Your Loan Eligibility Amount

Based upon that information provided by you in your loan application, banks calculate three important ratios as given below.

  1. Fixed Obligation to Income Ratio (FOIR),
  2. Loan to Value Ratio (LTV),
  3. Installment Income Ratio (IIR)

Your loan eligibility amount is calculated based upon each of these individual ratios and then minimum of these three eligibility amounts, your final loan eligibility is determined, which is mostly a minimum of all the three values arrived at. Let us go into details of these three ratios and understand how these are actually calculated.

What is Fixed Obligation to Income Ratio (FOIR)

This is the ratio of your fixed obligation to your income. To calculate fixed obligation to income ratio, banks consider the other fixed obligation of the customers which are currently due to him and indeed act as the maximum monthly repayment capacity of the customer. Statutory deductions like provident fund, professional tax, investment deductions like insurance premium, recurring deposit installments etc. are not included under fixed obligations.

FOIR is significant as it considers repayment of loans (existing and proposed home loan) from the applicant’s income. Your loan eligibility is determined in such a way that this ratio doesn’t cross the usual limit of 50%. This ratio is also known as Debt Service Ratio (DSR) or Debt to Income Ratio (DIT).

Following example may help you to understand how it is calculated.

What is Loan to Value Ratio (LTV)

Most of the banks and financial institutions shy away to finance more than 70% to 80% of the property value. Loan to value ratio sets the uppermost limit of the maximum amount of loan to be granted, irrespective of your eligibility for a higher amount depending upon your credit profile and your repayment capacity.

Loan to value ratio is limit of finance an individual can get based upon the property type and the value of the property. The “value” is the cost of the property and excludes furniture and fixtures, stamp duty, government charges or society registration fees.

Limiting the loan eligibility on the basis of LTV is very natural because the hypothecation or mortgage is based upon the property itself. By limiting the home loan eligibility to 70 to 80%, the lender actually protects himself from the possible downturn in the property cycle and the reduction in the property value in case the borrower is not in a position to repay the loan.

Following example may help you to understand how LTV is calculated.

ltv-calculations

What is Installment to Income Ratio (IIR)

Installment to income ratio helps lender to know the eligibility of a person to repay the loan. Lenders usually assume that a person can pay a maximum installment of about 35 to 45% of his monthly income. In case the total sum of all the EMI installments due to him increases more than this amount, he will not be able to sustain his lifestyle and is likely to default in future.

Following example illustrates how installment to income ratio is actually calculated

Image Credit (www.bankingvarsity.com)

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Disclaimer

Lots of approximations and assumptions have been made while developing the calculators.

Please make your own calculations before making any financial decision.