What is the Maximum Loan Amount?
The maximum loan amount refers to the highest amount that a financial institution or a bank authorizes an applicant to borrow. The maximum loan amount is applicable to credit cards, standard loans, and line-of-credit accounts.
- The maximum loan amount is the highest limit amount that a lender can allow an applicant to borrow.
- During the underwriting process, lenders approve the maximum loan amount by evaluating borrowers’ credit history and debt-to-income ratio.
- To access the maximum loan amount, a borrower must have a good credit history and a higher credit score.
Understanding the Maximum Loan Amount
There are several factors that come into play when determining the maximum loan amount during the underwriting process. Usually, the maximum loan amount is recommended based on the borrower’s debt-to-income ratio. The ratio helps lenders determine the possibility of the borrower repaying the loan and the maximum loan amount that each borrower can access.
A higher debt-to-income ratio suggests a higher burden on the borrower when paying back the loan. Lenders prefer borrowers with a debt-to-income ratio of, at most, 36%. Risk diversification of a lender can also determine the maximum loan amount to be authorized. Other factors that are considered during the underwriting process include credit history and credit score.
Unsecured lending is where financial institutions grant an unsecured line of credit while assuming a higher risk. In the event of a default, the borrower’s assets cannot be seized. An example of unsecured lending is a credit card. Issuers of credit cards determine the credit limit or maximum loan amount limit through the underwriting process.
Credit history is one of the essential factors that issuers consider when determining borrowers’ ability to repay a loan. Additional factors that credit card issuers consider are the derogatory remarks and the number of inquiries. For example, an applicant whose credit history is plagued with civil judgments, tax liens, bankruptcies, and collections may not qualify for a loan or may be limited to a low maximum loan limit. Issuers also take into account the work history of an applicant.
Unsecured credit cards for an individual or corporate borrower are difficult to access or qualify. Illustratively, a company may want to expand its business using a line of credit, and it will be required to repay the funds out of future business returns.
Lenders only consider providing such loans to a company with a good reputation and that is well-established. Even so, lenders charge higher interest rates or limit the maximum loan amount that the borrower can access to compensate for the increased risk. Therefore, lenders generally charge a higher interest rate on unsecured lines of credit due to the high credit risk.
Examples of Unsecured Loans
1. Personal lines of credit
Personal lines of credit are another form of unsecured loans that closely resembles a credit card and gives the amount of money to be used, as needed. One must have a good credit history and a higher credit score to qualify for a personal line of credit.
Until the funds are used, the lender does not charge an interest rate. As with other forms of credit, it can result in significant risk if not handled properly. The holder may spend any amount of funds provided, as long as the approval line of credit is not exceeded.
2. Personal loans
Lenders also issue personal loans in unsecured form. Lenders set the rates they are willing to lend based on factors such as debt-to-income ratio and credit card history. The credit card rating is directly proportional to the rates offered, meaning that the better the score, the better the offering rates. Borrowers with bad credit get higher rates than those with excellent credit. Personal loans are offered by peer-to-peer websites, banks, and other lenders.
Secured lending is a type of lending where loans are backed by collateral. In case of a default, the lender can seize the borrower’s collateral to recover the loss. The following are some examples of secured loans:
1. Mortgage loans
Mortgage loans are an example of secured lending where lenders use the housing expense ratio to determine the maximum loan amount to be allocated. The ratio compares borrower’s pre-tax income and housing expenses. Lenders consider expenses ratio of not more than 28%.
The housing expenses that lenders consider when calculating the housing expense ratio include risk insurance, mortgage insurance, property taxes, as well as mortgage principal and interest payment. As with standard loans, the common threshold required by lenders is a debt-to-income-ratio of 36% and below.
2. Home equity line of credit
Home equity line of credit refers to a form of secured lending that gives borrowers a maximum loan amount based on their home equity. It is comparatively better than a credit card because it offers a higher maximum loan amount while charging a lower interest rate. The downside of a home-equity line of credit is that the borrower risks losing their home if they default on loan repayments.
CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
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