What Is Borrowing Capacity?

"Borrowing capacity" is a term used to describe the total monetary amount of loans or credit that a lender is willing to extend to a client. Sometimes known as a borrowing limit, lenders will evaluate both individual and business clients to determine how much money or credit can be extended and still keep the level of risk associated with the arrangement within acceptable parameters. This approach is also used by many brokerage houses in determining how much a client can buy on margin without creating any type of financial hardship for the investor or the lender.

As part of the process of determining the borrowing capacity of an individual or business, lenders and creditors will investigate the financial stability and well-being of potential debtors. This will include assessing the current credit rating of a debtor as well as any holdings or assets that are currently in the possession of the applicant, especially those that are not pledged as collateral on other debt obligations. The income level of the applicant is also important, since the goal is to ensure that timely repayment of the amount loaned is feasible.

In some cases, borrowing capacity can be influenced by the willingness of the applicant to pledge certain holdings as collateral. For example, if an individual owns property that is currently free of any liens or claims, that property may be pledged as collateral in order to obtain some sort of loan. The lender will assess the current market value of the land to determine if that value is sufficient to cover the total amount of the loan. Assuming that the applicant does have enough income to repay the loan according to terms and the collateral is acceptable, the degree of risk assumed by the lender is kept within reason.

The idea of setting a borrowing capacity is to protect the interests of all parties concerned. Lenders set the capacity at a level that is balanced with the credit risk involved in doing business with the debtor while also allowing the opportunity to earn a return on the borrowed amount in the form of interest. At the same time, the imposition of a borrowing capacity also helps to prevent the applicant from taking on more debt that he or she can reasonably manage, which in turn minimizes the possibility for financial hardship leading to default. In order to protect the interests of both parties, lenders will sometimes determine the borrowing capacity of an applicant to be nil, based on factors such as income level, credit rating and other financial considerations. When this is the case, the loan application is rejected and the two parties do not enter into any type of working agreement.