Last Edited 10 months Ago by Dr. Utkarsh Amaravat
The debt-to-income ratio (DTI) and fixed obligation-to-income ratio (FOIR) are two financial metrics lenders use to assess a borrower’s creditworthiness. These ratios help lenders determine how much risk they would take if they lend money to an individual, which can then be used to decide whether or not to approve the loan application and what the loan terms would be.
Debt-to-Income Ratio (DTI)
The debt-to-income ratio measures an individual’s debt burden relative to income. It is calculated by dividing an individual’s monthly debt payments by their monthly income. The resulting ratio is expressed as a percentage. For example, if an individual has monthly debt payments of Rs.1,000/- and a monthly income of Rs.5,000/-, their DTI would be 20% (Rs.1,000/Rs.5,000).
The DTI is an important metric for lenders to determine whether an individual can afford the additional debt. Generally, the lower the DTI, the better the individual’s financial situation. A DTI of 36% or lower is typically considered good by lenders, while a DTI above 43% may make it more difficult for the individual to obtain credit.
Fixed Obligation to Income Ratio (FOIR)
The fixed obligation to income ratio measures an individual’s ability to meet their fixed monthly obligations, such as mortgage loan payments, rent, and car loans, relative to their income. It is calculated by dividing an individual’s total fixed monthly obligations by their monthly income. The resulting ratio is expressed as a percentage. For example, if an individual has a total fixed monthly obligationof Rs.1,500/- and a monthly income of Rs.5,000/-, their FOIR would be 30% (Rs.1,500/Rs.5,000).
The FOIR is a critical metric lender use to assess an individual’s ability to meet their fixed obligations. It is particularly relevant when assessing mortgage loan applications, as mortgage loan payments are often an individual’s most enormous, fixed obligation. A FOIR of 28% or lower is typically considered good by lenders, while a FOIR above 36% may make it more difficult for the individual to obtain a mortgage loan.
Differences between DTI and FOIR
While the DTI and FOIR are measures of an individual’s ability to manage debt, there are some critical differences between the two metrics.
The DTI considers all of an individual’s debt payments, including credit cards, car loans, and student loans, while the FOIR only assumes fixed monthly obligations such as rent or mortgage payments.
As a result, the DTI provides a broader view of an individual’s overall debt burden, while the FOIR focuses specifically on their ability to meet their fixed monthly obligations.
Additionally, the DTI is expressed as a percentage of an individual’s income, while the FOIR is described as a percentage of their fixed monthly obligations.
Another difference between the two metrics is that the DTI assesses an individual’s creditworthiness for all types of credit, while the FOIR is primarily used to assess mortgage applications.
When assessing mortgage applications, lenders may use the DTI and FOIR to evaluate an individual’s financial situation. In this case, the lender may be more interested in the individual’s FOIR, as mortgage payments are typically the most significant fixed monthly obligation an individual will have.
In addition to the differences mentioned above, it’s worth noting that the DTI and FOIR have different thresholds for what is considered a “good” ratio. As mentioned earlier, a DTI of 36% or lower is generally considered good by lenders, while a FOIR of 28% or lower is considered suitable for mortgage applications. It’s essential to remember that these thresholds may change depending on the lender and the type of credit being applied for.
Another critical point is that the DTI and FOIR are not the only factors lenders consider when assessing creditworthiness. Other factors such as credit score, employment history, and assets may also be considered. Additionally, lenders may have internal guidelines and policies for evaluating loan applications that go beyond the standard DTI and FOIR calculations.
It’s also worth noting that the DTI and FOIR can be improved by either increasing income or decreasing debt. For example, an individual with a high DTI can improve their ratio by paying down their debt or increasing their income through a higher-paying job or additional sources of income.
The DTI and FOIR can vary based on the type of income an individual receives. For example, if an individual has a significant non-salary income, such as rental or investment income, their DTI and FOIR may be calculated differently than someone who only receives salary income.
Similarly, the DTI and FOIR may be affected by other factors, such as child support or alimony payments. In some cases, these payments may be considered part of an individual’s fixed monthly obligations, while in other cases, they may not be included.
Overall, individuals need to be aware of their DTI and FOIR when applying for credit, particularly if they are applying for a mortgage. By understanding these ratios and how they are calculated, individuals can improve their creditworthiness and increase their chances of being approved for credit on favorable terms.
The debt-to-income ratio (DTI) and fixed obligation-to-income ratio (FOIR) are important metrics that lenders use to evaluate an individual’s creditworthiness. While they have few similarities, they also have critical differences in what is measured and how the ratio is calculated. It’s important to remember that these ratios are just one part of the overall credit evaluation process and that lenders may use additional factors and criteria when making lending decisions.
Dr. Utkarsh Amaravat
Author | 20+ posts
Dr. Utkarsh Amaravat is a banker with vast experience in retail credit. He holds a B.E. Mechanical and MBA Marketing degree from Gujarat Technological University and a Ph.D. in management (Credit Risk Management) from Sardar Patel University. He has mainly experience in sales and processing of credit proposals. Sales/Marketing, Relationship Management, Credit, and Risk Management, including research work are vital domains for him.
