Taking out a loan is inevitable, especially during financial emergencies or unplanned essential purchases. Though various financing options are more accessible these days, there are several factors you need to consider during the borrowing process. One of them is your borrowing capacity or the amount you’re able to borrow from a lender.
Whether your purpose is to cover a personal debt, medical bill, purchase a home or a car, it always makes sense to figure out how much you can borrow. By having an idea of your borrowing capacity, you can better look for an option that best suits your needs. It will also help you make adjustments without compromising the purpose of your loan.
To give you a more accurate picture, it would be best to know the different factors that may affect how much you can borrow on an auto loan.
Before any lender extends you the auto loan, they would want to assess how much you can realistically afford. One of the essential factors that they will look into is your income. Note that it gets the most percentage when lenders determine your borrowing capacity.
Lenders are interested to know how much money you’re earning every month to ensure it won’t be hard for you to make repayments. The general rule of thumb is that your monthly repayments must not exceed 30% of your after-tax salary.
When determining how much you can borrow, lenders are also likely to check any outstanding debts, and they may bear as much weight as your income. It’s because any outstanding debts or other financial obligations you constantly allocate your income towards can considerably affect your capacity to make monthly repayments on time.
Some debts may potentially decrease the amount you can borrow. In many instances, it may even result in loan rejection, especially when debt amounts consume a substantial portion of your regular income.
Your living expenses are another factor that can impact your borrowing capacity. Even if you are a high-income earner, how much you spend on day-to-day living can significantly decrease the amount you are eligible to borrow. These living expenses can range from basic expenses to discretionary ones.
Lenders take this into account to ensure that you have ample money left from your income to repay your auto loan even after settling your regular financial commitments. They usually use the Household Expenditure Measure (HEM) to assess borrower’s living expenses. Typically, the borrowing capacity will be less if there are more people and children in the household.
Your credit history also plays an important role when working out how much you can borrow on an auto loan. By looking at how you handle previous credit, lenders will know how reliable you are to meet financial obligations on time. If your credit history shows frequent missed bills and credit card payments, you may find it hard to borrow a higher amount.
On the other hand, you may qualify for a higher loan amount from a reliable lender like Credit Ninja if you have a higher credit score, which typically ranges between 670-730 or above. With such scores, lenders are likely to view you as less credit risk. Before lodging an auto loan application, it’s always a good idea to get a copy of your credit file.
Savings or Deposit Amount
Another way to gauge a potential borrower’s ability to make repayments is through the amount of their savings or deposits. That’s why during the loan application process, lenders usually require the borrower to shell out a certain amount of money through a deposit. If the amount you saved is larger, you have better chances to borrow more.
Bear in mind that lenders want to see that you can save money over a certain period. As a rule of thumb, lenders consider 5% of your deposit as genuine savings. Thus, the size of your deposit can impact the amount a lender will allow you to borrow.
Note that for auto loans, it’s recommended that you put at least 20% down payment. This way, you’ll pay less interest and you’ll get approved more easily. But if you don’t, you could end up upside down on your auto loan. It means that you owe more on the car than it’s worth immediately, which can eventually make it difficult for you to sell or trade.
Type of Loan
The type of loan you are applying for can also impact the amount you can borrow. If the loan has low fees, interest rates, and repayments, you can borrow a higher amount. A longer loan term may also allow you to borrow more since the monthly repayments are likely lower. However, you can save thousands in interest with a shorter loan term, and the downside is your borrowing capacity may decrease.
In the case of auto loan, a term that is not more than four years might be much more ideal. It’s because the car will lose a lot of its value by the end of four years, and you would not want to still be paying it off. In fact, it’s even better if you can pay it off in three years. But if you have to stretch your payments further, a five-year loan will do, yet never longer.
Moreover, lenders generally assess your capacity to make repayment at an interest rate around 2.5 higher than the rate at which the loan is offered. But if you’re applying for an auto loan with a fixed rate, evaluating your repayment capacity may be more lenient.
Ways To Boost Your Borrowing Capacity
If you think your borrowing capacity can hardly cover its intended purpose, consider the following ways to increase the amount you’re eligible to borrow.
- Pay existing and outstanding debts.
- Track your living expenses and make necessary adjustments.
- Maintain a high credit score by paying your debts and bills on time.
- Put more money towards savings.
- Reduce your credit limit, especially if you don’t need it.
- Make a monthly budget and stick to it seriously.
Know-How Much You Can Borrow
Knowing how much the lender is willing to lend you is essential to ensure that the loan is adequate to cover wherever you intend to use it. It also helps you to adjust your expectations or find other options that are most appropriate to your financial needs. After all, the loan must be able to serve its intended purpose.