Maximum Loan Amount
The greatest sum of money that a lender permits an applicant to borrow is based on their evaluation of their financial capabilities.
What Is The Maximum Loan Amount?
The maximum loan amount is the greatest sum of money that a lender permits an applicant to borrow based on their evaluation of their financial capabilities. This value is also referred to as the loan limit interchangeably.
The lender usually sets the loan limit, but the federal government can sometimes dictate this value.
For mortgages insured by the Federal Housing Administration, the administration sets the loan limits to account for differences in house prices across the various regions in the United States.
Because this number reflects drastically different living costs, it can fluctuate by nearly half a million dollars from state to state.
Government-sponsored institutions like Fannie Mae and Freddie Mac can also affect the maximum loan amount for some mortgages.
Like the FHA functions, these institutions aim to protect against mortgage defaults by setting loan limits on the mortgages they insure.
Furthermore, private lenders are another group of people that can restrict the most you can borrow from them. Depending on the loan type, credit score, and history, they may set different limits that reflect their risk assessment.
Credit card loans, for example, have lower credit limits than mortgages to reduce excessive borrowing without thoroughly examining your financial situation.
To put this into perspective, credit card limits are usually between twenty to thirty thousand dollars. In comparison, the maximum mortgage amount in some locations of the United States can reach up to eight hundred thousand dollars or higher.
In extreme jumbo and super jumbo loans, mortgage loan limits can reach as high as twenty-five million dollars! Therefore, the loan application process differs in these rare situations because the stakes are much higher.
In the modern day, state laws often govern this form of lending and set limits on jumbo loans. Typically, these loans hover around one to two million dollars.
Key Takeaways
- The maximum loan amount an individual can receive is the largest loan they can take out. This is determined by: The type of loan, company-specific policies, the borrower's credit, and the debt-to-income ratio
- In secured loans, the loan limit is usually set by the value of the offered collateral. In contrast, unsecured loans are based on the bank's analysis of the borrower.
- Getting a larger maximum loan amount is a task that can take years to accomplish. In the meanwhile, consider finding a less expensive hobby.
Understanding Maximum Loan Amount
The maximum loan amount varies between different types of loans, depending on their characteristics. However, it is generally shaped by income, credit score, debt-to-income ratio, collateral, and loan term.
Intuitively, this value increases when lenders consider the loan low-risk and decreases when the lenders consider it high-risk. Lenders like banks adjust this value according to each loan applicant to protect their interests and balance sheet.
A higher loan amount would only be approved on solid finances and fiscal responsibility, but it can have damaging effects. Therefore, ensure that the loan would not impose undue stress upon your financial situation and that the loan repayments are affordable.
Depending on whether the loan is secured or not, the consequences differ. For secured loans, the lending side can confiscate the collateral and sell it to recuperate their losses.
For unsecured loans, the lender can impose fines to force you to pay and even take legal action if you neglect the fees. Let's examine credit cards, for example.
In this case, the lender can charge high-interest rates on the pre-existing unpaid balance.
Over time, the new balance would be much more expensive to pay off. If not checked in time, this can create a downward debt spiral. Eventually, you can even be sued for the payments.
Over time, you will get poorer credit. Worse credit means borrowing will be harder because you are seen as less trustworthy.
Sometimes, it is advisable to avoid borrowing to the maximum loan amount. Credit bureaus, for example, do not look favorably upon spending to the credit card limit and will lower your overall credit score.
Note
In most circumstances, spending less than thirty percent of your credit card limit is suggested.
How is the Maximum Loan Amount Calculated?
A loan underwriter evaluates the previous factors and produces a value matching the borrower's risk assessment and the loan.
Although companies approach this evaluation differently, there are some similarities:
- Debt-to-income ratio: This measure can be found by dividing the monthly debt owed by the monthly gross income. Most lenders look for a value of 36% to measure your ability to take on additional debt obligations.
- Credit history: Institutional lenders often evaluate borrowers’ reliability and consistency in making payments by screening their credit history. People with a strong credit history are likelier to obtain a higher loan limit.
- Credit score: Measures like the FICO credit score are also used to evaluate a borrower. Those with poor credit scores are charged excessively higher interest rates than those with excellent scores.
Note
It is critical to remember that institutions also have different policies regarding borrowing, which may affect their willingness to lend. In addition, whether a loan is secured by collateral can dramatically change the amount you can borrow.
Example of Maximum Loan Limit
Let's work through a scenario of someone who's currently about to buy his first house.
After months of debate, he finally settles on a townhome overlooking a local park in a suburban region. This particular client earns an annual gross income of seventy-eight thousand dollars.
In the process of determining a responsible loan limit, the bank evaluates his background and financial history.
The loan underwriter finds that this person has a monthly gross income of $6,500. In addition, he spends $1,500 on things like auto loans and other fixed expenses.
In this scenario, our client would have a debt-to-income ratio of around twenty-three percent (1,500/6,500), much lower than needed to get this loan.
The fictional bank would likely conclude that this person could make the mortgage payments on time. However, when evaluating his credit, the underwriter finds that this client only has a fair credit score due to a previous bankruptcy.
Over the years, although his credit score rose slightly, it is still lower than most home buyers.
As a result, the bank offers him a maximum loan limit on his mortgage of, say, two hundred thousand dollars at a relatively higher interest rate—6.3% APR (Annual Percentage Rate).
In addition, the underwriter decides on a shorter loan term of 10 years due to uncertainty about the borrower’s financial habits.
What if our home buyer was a newlywed with a joint family income of $160,000? Now what if he owned his car and did not have to make payments on an auto loan?
In the first scenario, our client's boosted income would directly cause the debt-to-income ratio to fall. As a result, the bank would approve a larger loan because the family’s ability to pay is higher.
In the second case, the car could be used as collateral to secure the mortgage. Even if his finances were unstable and he had poor spending habits, the collateral would reassure the financial institutions, potentially leading to a higher loan.
What is Secured Lending?
Secured lending involves loans backed by collateral. In the event of a default, the lender can seize the collateral and sell it to avoid losses.
Because this form of lending provides greater security to institutional lenders, it often comes with many benefits.
Secured loans offer reduced interest rates and boosted maximum loan limits compared to their unsecured relatives. However, the risk is also greater for borrowers in the case of default because they could lose their assets.
Secure Lending Examples
Let’s consider some examples.
- Home equity line of credit (HELOC): This form of secured loan allows borrowers to borrow an amount equal to a portion of their home equity while using the house as collateral.
- If the borrower defaults, the bank could foreclose on the home. However, this method affords institutional lenders great security in creating these loans, which usually results in higher loan limits and lower interest rates.
- Mortgages: As one of the older lending institutions, mortgages have centuries of history. A mortgage uses the property as collateral, such as a home, to secure the loan. This form of borrowing allows the lender to seize it through foreclosure if the loan repayments are not paid.
- Considering the cost of modern homes, mortgages usually have loan terms of 10 to 30 years. Longer mortgages tend to have higher interest rates than shorter mortgages due to greater uncertainty.
- As a result, the total interest paid over a longer mortgage is also drastically higher than in shorter mortgages.
- Auto loans: Auto loans are similar to mortgages but consider the vehicle to be collateral instead. Like other forms of secured lending, auto loans have lower interest rates and higher loan limits than unsecured loans.
- Secured personal loans: Secured personal loans can be obtained for various purposes, creating versatility in usage. However, the loan limit is determined by the collateral used to back this borrowing.
- For example, a bank account used as collateral will only permit borrowing up to the amount equivalent to the account balance.
- Secured credit cards: Secured credit cards require a security deposit upon setting up. The institution that issued the credit card holds this deposit as collateral, refunding it when the account is closed.
- In other aspects, secured credit cards work just as regular credit cards do, allowing purchases up to a loan limit determined by credit and the security deposit.
- Business loans: Business loans are a way for businesses to acquire funding for their operations. The loan limit varies depending on the business’ assets and how much they can put up as collateral.
- In the case of default, the business could attempt to raise funds (through debt financing and other methods) or submit to the seizure of its assets.
Note
The interest rate for business loans varies depending on the lender’s assessment of the company’s background and credibility. More established companies likely to pay off their loan will receive lower rates and vice versa.
What is Unsecured Lending?
Unlike secured lending, unsecured lending involves a more risky form of loan not backed by collateral. To compensate for this risk, institutions like banks and credit unions charge higher interest rates and limit the maximum loan amount to avoid major losses.
While these two forms of lending have some similarities, it is important to note their differences that result from the lack of collateral. Here are some examples:
Personal Loans
Personal loans without collateral function similarly to secured personal loans. However, loan limits are typically more stringent and are based on an extensive credit history analysis.
In the case of default, fees and penalties are imposed to deter borrowers from excessive borrowing.
Collection agencies can take steps to collect unpaid loans by contacting someone, suing them, or taking legal action to impose penalties like wage garnishment, which systematically deducts funds from wages to pay off the loan.
Credit Cards
More than just pieces of plastic with invaluable numbers on them, credit cards are a type of revolving credit that puts a periodic limit on the amount you can borrow.
Credit card limits depend on your credit score and debt-to-income ratio.
Note
Your credit score can go down if you spend the entirety of the loan limit.
Student Loans
Student loans are another type of unsecured lending offered to young adults. Students, who do not yet have houses or cars, lack the collateral for secured loans.
Despite this, the Department of Education offers some risk protection on student loans for financial institutions because it views investment in education as an investment in human capital.
College-related costs like tuition, room and board, and other expenses determine the maximum loan amount in student loans.
However, private lenders also evaluate credit history, among other factors, when deciding the loan limit. Furthermore, this value varies between undergraduate and graduate studies.
Business Loans
Unsecured business loans differ from secured relatives because they tend to have shorter loan terms and higher interest rates.
When evaluating a firm to approve a business loan, institutions assess the business’s financial security by evaluating cash flow and balance sheet metrics.
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