A legal lending limit is the total amount that a financial institution can commit to a single borrower. This includes all types of financial services, including unsecured loans, mortgages, lines of credit, and another other type of financial service. Governmental regulations that provide the basis for calculating this legal lending limit vary somewhat from one country to another, but most standards include considering both the general financial condition of both the borrower and the lender in order to identify the actual amount of the limit.
For lenders, the overall net worth of the institution is very important to arriving at an accurate legal lending limit. This includes allowing for the assets in hand as well as any type of equity capital and investments that the banking institution currently holds. Information of this type is important, since it serves to underpin the ability of the lender to honor commitments to their customers, including those who are extended a loan or credit by the institution.
Calculating a legal lending limit also requires assessing the ability of the borrower to repay any debt within the terms associated with the contract with the lender. Here, the credit standards used by the lender to evaluate applications come into play. If an applicant is found to have too much existing debt, inadequate income, an uneven credit history, or any combination of these three, he or she may represent an unacceptable risk to the lender. That same applicant may qualify for a loan or mortgage of a lesser amount, since the lower figure would translate into less risk for the lender and installment payments that would be within the means of the borrower.
In most countries, the regulations associated with determining a legal lending limit are created and enforced on a national level. This helps to ensure consistency among lenders of the same type, while also protecting the financial interests of lenders as well as individuals and businesses that seek loans and other types of financial transactions. For example, regulations that govern this process in the United States are defined within the Financial Institutions Act of 1989. As part of the function of this and other regulations, the provisions place maximum percentages of lending for each type of institution.
It is important to note that the percentage varies from one institution to another; the limit applied to a savings and loan association is different from that of a bank, or that of a holding company. As long as the terms of the loan remain within these maximum allowed amounts, the transaction is considered legal and binding, and is free of any sense of being classed as an unlawful loan.