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Loan Capacity Formula:
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Loan capacity refers to the maximum amount a borrower can afford to repay based on their income, existing debt obligations, and prevailing interest rates. It helps lenders and borrowers determine a reasonable loan amount.
The calculator uses the loan capacity formula:
Where:
Explanation: This formula calculates how much debt a borrower can service based on their income, the portion of income allocated to debt payments, and the cost of borrowing.
Details: Calculating loan capacity is essential for responsible lending and borrowing. It helps prevent over-indebtedness, ensures borrowers can comfortably make payments, and assists lenders in assessing risk.
Tips: Enter income in your local currency, debt ratio as a decimal (e.g., 0.36 for 36%), and interest rate as a decimal (e.g., 0.05 for 5%). All values must be positive numbers.
Q1: What is a typical debt ratio used by lenders?
A: Most lenders use a debt-to-income ratio between 0.36 and 0.43, meaning 36-43% of income can be allocated to debt payments.
Q2: Should I use gross or net income for this calculation?
A: Lenders typically use gross income, but for personal budgeting, net income may provide a more accurate picture of affordability.
Q3: How does loan term affect capacity?
A: This simplified formula doesn't account for loan term. For more precise calculations, use a loan amortization formula that considers repayment period.
Q4: Are there other factors that affect loan capacity?
A: Yes, lenders also consider credit history, assets, employment stability, and other financial obligations not captured in this basic formula.
Q5: Can this formula be used for different types of loans?
A: While the basic principle applies to various loan types, specific loan products may have unique qualification criteria beyond this calculation.