Borrowing Capacity: What it is and How to Calculate It Step by Step

Debt is something that for many people is negative, frightening, and therefore, avoided at all costs. But, despite all this, the reality today is that debt is often unavoidable, and what's more, if you manage to understand how the world of debt and credit works, you can use it to your advantage. How? We'll tell you in the following post.

What is debt capacity?

Debt capacity is the maximum amount of money an individual or company can borrow without jeopardizing their financial stability. It is calculated as a percentage of their profitable passive incomeavailable, and healthy debt is considered to be debt that does not exceed 35% of total income.

Importance of knowing your debt capacity

Knowing your debt capacity helps you make responsible financial decisions and maintain solid financial health. It allows you to determine how much you can borrow without compromising your financial stability, thereby avoiding over-indebtedness that could affect your quality of life.

Informed decisions

By knowing how much you can borrow without compromising your financial well-being, you can realistically assess whether a new loan or credit is suitable for your situation. You'll be able to compare different financing options and choose the one that best fits your needs and means.

Avoid over-indebtedness

If you borrow beyond your capacity, you will very likely have difficulty making your payments, which would lead to over-indebtedness. This generates stress, affects your credit history, and makes it harder for you to access future loans.

Helps you maintain a good credit history

A good credit history is essential for accessing better financing terms in the future. If you pay your debts responsibly and maintain healthy debt levels, you will be strengthening your credit history.

Allows you to achieve your financial goals

If you manage your finances responsibly and avoid excessive borrowing, you'll be able to save towards achieving your financial goals, such as buying a house, a car, or taking a trip.

Provides peace of mind and control over your finances

Knowing your debt capacity allows you to better understand your financial situation and gives you the peace of mind of knowing that you are managing your debts responsibly.

Factors that determine your debt capacity

To fully understand what debt capacity is, you need to clearly understand the factors that influence or determine it. Therefore, we'll outline them below: 

Income

Financial institutions assess an applicant's regular and stable income to determine their repayment capacity. The higher the income, the greater the borrowing capacity.

Debt-to-income ratio (DTI)

This ratio compares monthly debt payments to monthly income. Lenders generally prefer a low ratio, as it indicates that the borrower has sufficient disposable income to take on new debt.

Credit history

Financial institutions will review the applicant's credit history to assess their past behavior regarding debt. A positive credit history, with on-time payments and no excessive debt, increases borrowing capacity.

Employment history and job stability

Job stability and a consistent employment history also influence the decision to grant credit. Lenders typically prefer applicants with stable and consistent jobs, as this translates to a greater ability to repay debts.

Monthly expenses

In addition to income, lenders also consider the applicant's monthly expenses, such as rent, mortgage, utility bills, insurance, etc. These expenses affect the amount of income truly available to pay new debt.

Collateral

In some cases, borrowing capacity can increase if the applicant is able to offer collateral such as property, a car, or other assets that can be used as security for the loan.

Loan term

The loan term also affects borrowing capacity. The shorter the loan term, the higher the monthly payments, which can reduce the amount of debt a borrower can manage.

How to calculate your borrowing capacity?

Here's a simple step-by-step guide on how you can calculate your borrowing capacity: 

• Step 1. Add up your monthly income: Include your salary, rental income, investments, etc. Make sure to consider all your regular income.
• Step 2. Subtract your fixed expenses: Include housing, food, transportation, insurance, etc. Fixed expenses are all those costs you must pay each month, regardless of your income.
• Step 3. Subtract your variable expenses: Leisure, entertainment, clothing, etc. Here you should include all expenses that vary month to month, such as birthday gifts, dining out, social gatherings.
• Step 4. Multiply the result by 0.35: Once you have the subtraction result, multiply it by 0.35; this will give you a percentage. This is the maximum percentage of your income that you can allocate to debt payments. Remember that healthy debt is considered to be no more than 35% of income.

Example: If your monthly income is €1,000 and your fixed and variable expenses total €700, your borrowing capacity would be €105. This means you could borrow a maximum of €105 per month without jeopardizing your financial stability.

Tips for increasing your borrowing capacity

Increasing your borrowing capacity is a strategic financial goal that can open numerous doors, from purchasing a home to launching a business. However, achieving it requires careful planning, commitment, and smart financial decisions. To help you out, here are some tips: 

Increase your income

The first step towards a greater borrowing capacity is to increase your income. This can be achieved by securing a higher-paying job, taking on side projects, or investing in opportunities that generate passive income. The key here is to diversify your income sources so that you don't rely solely on your salary. Starting a business in areas of interest or investing in the market for net asset values are viable options, provided you educate yourself adequately about the risks and potential returns.

Optimize your expenses

Efficient management of your superfluous expenses is as crucial as increasing your income. Creating a detailed family budget will allow you to identify areas of excessive spending. By reducing unnecessary expenses and seeking economical alternatives in your consumption habits, you can free up a larger portion of your income for saving or investing. Renegotiating the terms of your existing debts can also significantly decrease your monthly financial obligations.

Improve your credit history

Remember that a solid credit history not only improves your financing options but also qualifies you for more favorable loan terms. You can achieve this by keeping your debts at manageable levels, paying on time, and using credit strategically. Always monitor your credit history; doing so will allow you to identify and correct any inaccuracies that could negatively affect your score.

Cultivate the habit of saving

Demonstrating the ability to save is fundamental for businesses, individuals, and families alike. This means having guaranteed investment funds set aside for emergencies and future goals. A good saving habit demonstrates prudence and foresight, qualities highly valued by lenders. You can choose the Kakebo method for your finances, the 52-week savings method or the 50-30-20 rule

Seek professional financial advice

Navigating the complex world of personal finance can be overwhelming. Professional financial advice can provide you with a personalized roadmap to improve your borrowing capacity. An advisor can help you adjust your financial planning, optimize your credit profile, and explore new investment avenues.

Increase your borrowing capacity by investing in real estate

Investing in real estate is a traditional financial strategy that continues to prove effective for increasing borrowing capacity. By acquiring a property, you are not only creating a tangible asset that appreciates over time, but you can also access financing with lower interest rates and longer terms. However, jumping into property investment without much knowledge of investments or the real estate business is extremely risky. That's why Domoblock offers you an innovative platform for fractional real estate investment, allowing you to access this market without needing large sums of money. Through us, you can:

• Invest with confidence: With Domoblock, you can become a real estate investor with as little as €200.
• Guaranteed profitability: Recover your real estate investment in less than 8 months and enjoy an annual return of over 10% on a secure asset.
• A global community: Join over 350 investors from 12 different countries and become part of a diverse and thriving community.
• Quick and commission-free registration: Our registration process is fast and transparent, with no hidden fees.
• Intuitive platform: Invest with just a few clicks through our 100% automated platform.
• Guaranteed security: Your investment will be protected. If we don't reach the funding goal, you'll get your money back without any hassle.
• Revolutionary tokenization: With tokenization, you can easily invest small amounts thanks to our blockchain technology.
• Higher returns, lower costs: We use blockchain because it allows us to reduce costs and increase profitability, so you can achieve your financial goals faster than ever!

If you're ready to start investing or venture into the world of real estate investment, Domoblock is the platform specializing in real estate crowdfunding and the real estate tokenization is your safest option. 

Conclusion 

In summary, understanding your borrowing capacity allows you to make responsible financial decisions, avoid over-indebtedness, and maintain control over your finances. Remember that borrowing beyond your means is detrimental; it can cause stress, affect your credit history, and hinder access to future loans. Broaden your perspective on debt and start evaluating the possibility of using it to build a beneficial credit profile for your future plans.