Evaluating your borrowing power before taking a loan is imperative to prevent default and stressful repayments. The ‘borrowing capacity’ allows you to assess your income, spending, savings, assets, liabilities or dues, etc., and determine how much you can borrow. For example, if you are planning to buy an asset like a home and need a loan, you may be unable to determine the loan amount. Calculating the borrowing capacity will help you know your ideal loan principal amount.
Let us discuss what borrowing capacity is and how to calculate it.
What Is Borrowing Capacity?
The borrowing capacity refers to the amount of money that a person or business can borrow without facing difficulty in repayment of the same. The borrowers should assess their borrowing capacity and apply for a comfortable loan amount, while lenders evaluate the individuals’ loan capacity before approving the debt. This is imperative for them to ensure that the borrower repays the full debt and interest to the lender.
The borrowing capacity is calculated considering different aspects. The factors include income, assets, credit history, market conditions, etc. You can use an online borrowing capacity calculator to know the ideal amount you should borrow.
How to Determine Borrowing Capacity? Top Factors
As mentioned above, multiple factors play a role in calculating the borrowing capacity. Different lenders have their own methods of calculating the borrowing power. Hence, the loan terms and amounts differ from each other. The most common factors that are considered while calculating the person’s borrowing power include the following:
- Income or monthly salary
- Assets, including properties, stocks, bonds, etc.
- Liabilities like existing dues, credit card outstanding, etc.
- Number of new loan applications
- Living expensesCredit repayment or history
If a company has submitted a loan application, the lenders evaluate the borrowing capacity based on the factors like:
- Financial ratios, including cash flow, coverage, leverage, profitability ratio, etc.
- Competitive edge
- Past financial performance
- Management strategy
- External factors like the type of industry, the scope of growth, cyclicality, market sentiments, industry structure, etc.
How To Calculate Borrowing Capacity?
The lender assesses several aspects like income (regular and additional), debts, expenses, etc. The borrowing capacity formula also includes credit score, income against liabilities, etc.
Some lenders calculate the borrowing capacity using one of the two formulas. According to the first one, the lenders calculate the debt-to-income ratio. To calculate the same, they divide an individual’s overall debt with their gross income. The other method is when the lenders focus on the surplus income of the borrower. To calculate the same, they subtract the overall net income of an individual from the overall repayments.
Other than the ones mentioned above, the lenders also consider factors like the number of people in the family (dependants), current repayment schedule, and ongoing loans like personal loans, car loans, home loans, etc. They also check whether the lender has private health insurance and any other substantial financial obligations. These things impact individuals’ savings and new loan repayment.
When assessing the home loan borrowing capacity, the lenders include a percentage of the interest rate, too. This test is essential in finding whether an individual will repay the loan with interest over the long term.
The individuals can also determine their borrowing capacity by using a free borrowing capacity calculator online.
How To Increase Borrowing Capacity?
Here are some ways to increase borrowing capacity:
Increase Income
If you can generate more income, then you can increase your borrowing capacity as well. Either try for a salary raise with your current employer or look for a new job that pays you a higher salary. Some people also join part-time work or work as freelancers to increase their total payout. A higher salary will take your borrowing power up.
Keep Your Expenses Low
How have you planned your budget? Have you segregated your fixed monthly payments and variable components? Well, you cannot change your fixed expenses, but surely work on your variable component. Exclude these expenses from the total income and check how much you can save every month. Try to reduce your monthly spending and increase your savings to enhance your borrowing power.
Reduce Dues
If you can lower your existing dues, it will boost your borrowing capacity. The lenders approve the loan amount after checking your existing dues. Try to pay off your existing loans before applying for a new loan.
Longer Loan Term
If you take a loan for a longer term, you will lower your EMI and your borrowing power will be increased. However, doing so will mean paying more interest in the long term.
Improve Credit Score
Other than the ones mentioned above, increasing your credit score is also important to boost your borrowing capacity. The applicants with great credit score receive good loan amount at a lower interest.
Wrapping Up
It is important for lenders to evaluate the borrowing capacity of an individual or business so that they do not risk their funds and recover the same with interest. This is the reason why when a person or company applies for a loan, the lenders check the borrowing power before sanctioning it. Use the borrowing capacity calculator to check your borrowing power, try to increase it, and then apply for a loan!
FAQs
What is the borrowing capacity?
Ans. The borrowing capacity is a loan amount that an individual or business can get and then repay the same without any challenges.
How is the individual’s borrowing capacity calculated?
Ans. The borrowing capacity depends on various financial and economic factors like income, assets, other dues, savings, market trends, and more.
How is the business’s borrowing capacity calculated?
Ans. The lenders evaluate the borrowing capacity of a business on cash flow, coverage, leverage, profitability ratio, competitive edge, past financial performance, management strategy, market sentiments, industry structure, etc.
How can I calculate my borrowing capacity?
Ans. The individuals can determine their borrowing capacity by using a free borrowing capacity calculator online.
How is it important for the lenders to determine the borrower’s capacity?
Ans. The lenders determine the borrowing capacity of the person or business before approving the loan so that they are sure that the latter will repay the dues on time.
How can I increase my borrowing capacity?
Ans. You can increase your borrowing capacity by reducing the existing debt, lowering the monthly expenses and increasing savings, increasing the income potential, etc.
Do credit bureaus also calculate the borrowing power?
Ans. No. The lenders calculate the borrowing power, while credit reporting agencies calculate the credit score.
How can to increase borrowing capacity?
Ans. Increase borrowing capacity by increasing your salary, cutting expenses, increasing savings, paying debts, and boosting your credit score.