The borrowing capacity of a household refers to the maximum amount that the household can repay monthly, if a loan is granted. The maximum amount is calculated according to the income and expenses (mortgage, consumer credit) of the household who wishes to borrow. The borrowing capacity corresponds to the debt capacity of the household.
Borrowing capacity and debt ratio
Before granting a loan to a customer, a bank will always seek to identify the borrowing capacities of its customer. To measure the borrowing capacity of a household, the maximum monthly payment that the customer can repay, the bank will identify the household debt ratio. The debt ratio is the part of the income which is exclusively devoted to the repayment of loans. By loans, we mean both consumer loans and mortgage loans. The maximum debt ratio accepted by banks is 33%. However, depending on household income, the debt ratio tolerated by the bank may fluctuate. Thus, when the household wishing to obtain a loan has large income, then the bank will easily accept to exceed the threshold of 33%. Indeed, for a household with a comfortable income, even with 40% debt, the remaining income will allow it to maintain a comfortable lifestyle.
But if the income of the acquiring household is low, the bank will impose a debt ratio of less than 33%, to grant the loan. Indeed, when household income is low, the impact of loan repayments on household income is much greater, the household can quickly find itself in difficulty.
To calculate the borrowing capacity of the household, the financial organization lists all its income:
- Salaries, wages, contractual bonuses, 13th month,
- Non-salaried professional income
- Income from movable property
- Real estate income
Salaries, wages and contractual bonuses, and the 13th month are taken into account by all financial organizations. However, the inclusion of certain income in the calculation of the borrowing capacity is at the sole discretion of the financial institution. These revenues include allowances, movable and immovable income. Some banks refuse to take allowances into account, because they are intended for children, and they are difficult to enter.
For employees receiving commissions, the inclusion of commissions varies depending on the establishment. Some financial organizations will take into account the commissions received by averaging over a determined period (3 months, six months, one year, etc.), others still will not take them into account at all. Thus, the borrowing capacity of a household can fluctuate substantially from one financial institution to another.
When all the household income has been identified, the lender then identifies the household debts. As a result, he asks the household to list all of its current loans. The loans to be identified represent both consumer loans and mortgage loans.
Simulation of borrowing capacity
Today, consumers can directly obtain their borrowing capacity online. For this, it has many online borrowing capacity simulators. The information he must communicate to acquire this information is:
- Household income
- Current household loans.
These criteria alone are not sufficient to calculate the maximum monthly payment that the borrower could support, because other variables come into play to obtain this data. Indeed, the interest rate, the duration of the credit are important factors in determining the borrowing capacity.
While borrowing capacity is an important part of the loan record, banks also rely on other factors to determine how much a borrower can get.
Real estate loan
In the context of a mortgage, to determine the borrowing capacity, certain financial organizations in addition to current loans will identify all household expenses. These charges take into account rent, food, health ... The borrower can calculate them himself, the best way being to rely on his bank statements. However, if it is the purchase of the household's main residence, no financial institution will take the rent into account. This is explained by the fact that by financing the purchase of his main residence, the borrower will no longer need to pay rent, since he will live in the financed property.
Depending on the purchase plan, the amount intended to purchase the property may vary. Indeed, the notary fees are higher in the case of old goods. While, for old properties, the notary fees are around 8%, new properties have notary fees ranging between 2% and 3%. As a result, for the same borrowing capacity, the value of the financed good will be lower if the household wishes to acquire an old good, than if it plans to acquire a new good.
Other factors such as the length of the loan and the interest rate influence the capacity of the loan. In the current context, marked by very low interest rates, households' borrowing capacities are higher than if interest rates were high. Thus, while in 1991, the average interest rate observed for a mortgage was around 9%, today, this average rate has risen to 1.6% (rate excluding insurance). But if borrowing capacities are higher in 2016, so are the prices of goods.
By calculating the borrowing capacity, the banker determines the maximum monthly payments that the borrower can support. Also, in addition to the borrowing capacity, it calculates the remainder of the household. For the banks, the remainder to live is the amount that remains in the household after having paid the payment of its credits, and its current expenses. Thus, the remainder to be lived takes into account the expenses of housing, health, energy (electricity, gas), food, transport… In general, the financial organizations establish thresholds for the remainder to be lived. Each financial institution is free to determine its minimum remainder. The remainder to live may vary depending on the borrower. The level of remaining living required by the bank depends on the size of the household, as well as the geographic location of the household.
In addition, the banker also analyzes his management of his income. Is the borrower saving? Is he living beyond his means? Is it constantly in the open? As a result, for two households that are a priori identical, the rest to live required for the borrower may be different. This indicator belongs to the many indicators used to analyze the borrower's credit report.
As with mortgage loans, when it comes to acquiring consumer credit, the lender identifies the borrowing capacity of the household, and its remainder to live.
Legally, the financial institution that issues the credit can rely only on the form completed by the customer if the credit granted does not exceed $ 3,000. But when the credit is greater than $ 3,000, the financial organization is forced to require a certain number of proof, including proof of income.
The borrowing capacity is an indicator which aims to avoid over-indebtedness of the consumer. Thus, whatever the desired credit, the financial institution will always try to establish the borrowing capacity of the acquirer. All credit reports should be completed in good faith. If a consumer in a situation of over-indebtedness had failed to report all of his loans, when taking out one of these bank loans, in order to camouflage his level of indebtedness, then his file would not be admissible in a over-indebtedness commission. The good faith of the applicant being one of the key elements to obtain an admissible file which would allow the borrower to see his debts erased.
In addition to the borrowing capacity, the rest to live, and the management of the household budget, lenders take into account credit scoring. All the factors taking into account to determine the level of risk of the borrower are grouped together in the credit scoring. The better the credit scoring, the more chances the borrower will have of obtaining the loan he wants at an advantageous rate. The scoring takes into account the following factors:
- The age of the borrower
- The profession
- The number of children ...
For each of the factors below, the borrower will have a score but for each factor the coefficient will be different.
Each financial institution having its own evaluation grid, for the same mortgage loan file for example, the evaluation made could be different depending on the financial institution. Having a good loan record is essential for the borrower, in doing so, it increases their borrowing capacity. When the borrower has a good record, he or she is able to get a lower interest rate. Finally, when a household wishes to obtain a loan, it has every interest in contacting many financial institutions in order to compare the proposals, it can then choose the institution that will make the best proposal.