Almost anybody can get a loan of some sort. In fact, in America alone, 77 percent of all households, both rich and poor, have some type of debt, be it a personal loan, a mortgage, student loans, or other types of financing.
But have you ever noticed when applying for a loan that lenders will give you a maximum loan amount? Although they make money when you borrow as much as possible, there is a ceiling. They can’t just give you all the money in the world.
Wondering how lenders cap your desired loan amount? Want to know what the conforming loan limits are and how they are calculated?
Everything you need to know about loans and their maximum borrowing limits is covered below.
Why Do Lenders Have a Maximum Loan Amount?
Lenders, such as banks, make most of their money by earning interest on the money that they lend to their customers. On mortgages, they might make 5% interest while on credit cards they’ll make around 17% interest or more.
But lending money involves a huge amount of risk. If a customer borrows money, and experiences hardship, and can no longer make loan repayments, they might need to declare bankruptcy or foreclose on their home.
In these instances, the lender loses most, if not all, of the money they lent out.
So lenders are very particular about who they lend to, and how loans are structured. One of the parameters that lenders use to manage their risk is the maximum loan amount.
Lenders want to know that each loan they make works within the current monthly budget of the customer. They want to ensure their customer can comfortably make their monthly payments. If that happens, the lender stands to earn interest for many months, if not decades.
Loan Limits in Action
For example, if a customer makes $3,000 per month, and wants to borrow a lot of money, the lender will decide how much they can afford to pay each month. Would this person be comfortable paying $1,500 per month, or half of their monthly income, just to repay a loan?
Probably not. A well-structured loan, with a reasonable loan limit, might mean this customer is paying $300 per month, or just 10% of their monthly income, which is very manageable.
When debt payments are low enough, consumers are more likely to make these payments on time every month, benefitting both the lender and the borrower, as their credit scores won’t decline.
Without a limit in place, many irresponsible borrowers would take on more debt than they could ever repay. Not only would this wreck the life of the customer, but it would cause the lender to lose much more money.
So the loan limit is just as much a service to us as it is to the lender.
What Determines the Maximum Loan Limit
Underwriters who write individual loans for consumers have a number of factors they consider when determining the maximum loan amount. This amount varies from person to person since no two borrowers are exactly the same.
Monthly income, monthly debt repayments, credit score, and collateral all affect the total loan limit that is put in place.
One of the biggest factors is a borrower’s debt-to-income ratio (DTI). This is the amount of money currently spent on debt repayments each month, compared to their monthly, pretax income.
In our example above, getting a loan with $300 monthly payments means that their DTI is 10% since their monthly income is $3,000.
If they got another loan, their DTI would increase. Lenders want to ensure that most of the time, borrowers do not exceed 36% DTI, which would be $1,080 in monthly debt repayments for a figurative borrower mentioned above.
What Types of Loans Have Limits?
Loan limits apply to every type of loan, especially unsecured loans. Unsecured loans are those without any collateral. Without collateral, these will have higher interest rates and lower loan limits, to help protect the lenders.
Unsecured loans include personal loans, credit cards, and personal lines of credit (LOC).
Secured Loans
Mortgages are different, however. When you get a mortgage, the loan is secured by the property that you buy. This is why getting a mortgage is relatively easy since it’s less risky for lenders.
Even though you are borrowing a lot of money, lenders know that if you fail to make payments, they can take the house back (foreclosure). They can then sell the property to make up for the money the loan that you failed to pay back.
Due to this collateral, the maximum loan amount mortgage companies offer is much higher than you could get with any other type of loan. Your mortgage limit is determined by your monthly income, credit score, and current outstanding debt.
The less you owe on other loans, the more you can afford a mortgage payment, so the higher your loan limit will be.
Wondering how to calculate the maximum loan amount for mortgages? It depends on what the monthly mortgage payment will be. Lenders want to ensure your mortgage-related expenses will not be more than 28% of your monthly, pretax income.
You can use an online maximum loan amount calculator to get a rough estimation of what to expect.
Tips for Getting a Loan
There are a lot of reasons to get a loan and a lot of things you can do to increase your chances of getting a favourable loan.
When you apply, make sure to have all of your financial information handy ahead of time. You’ll want to know how much money you make per year, not just per month.
Not sure how much you make over the course of 12 months? Use a YTD calculator to make it easy.
Other than knowing your numbers, you’ll want to take some time to improve your credit score as much as possible by checking for errors, paying down current loans, and making all payments on time, every time.
Be Grateful for Loan Limits
The maximum loan amount is just a fact of life for the majority of people who take on debt at some point or another. But don’t be mad at the lender for putting a limit on your borrowing power.
Remember, these limits are there to protect you just as much as it protects them.
Looking for more financial tips like this? Head over to our blog now to keep reading.
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