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Financial Dictionary - Borrowing capacity

Borrowing capacity

Borrowing capacity or creditworthiness is the maximum amount that a company or individual can borrow without jeopardising their financial solvency.

Standard borrowing capacity is between 30% and 40% of income, which means that debt should never exceed 1/3 of the individual's remuneration. The Bank of Spain advises that the maximum amount that a family borrows should not exceed 35%. This allows the remaining 60%, 65% or 70% of income to be used for essential expenses and for savings.

Financial institutions use borrowing capacity as one of the indicators when granting or refusing a line of credit. This information helps banks to ensure that they are going to recover the total amount loaned and the interest.

Which factors determine borrowing capacity?

Borrowing capacity is determined by several factors:

  • The borrower's current assets and income.
  • Financial solvency or the ability to generate income now and in the future.
  • Endorsements or guarantees from third parties and the existence of other alternative means of payment.

How can I calculate my borrowing capacity?

To understand our borrowing capacity, we need to know our total monthly income and fixed expenses.

  • Total income: payroll and income from deposits, investments in securities or rented apartments.
  • Fixed costs: rent, credit payments, travel, education or food expenses, other loans or recurring bills.

There are a number of variable expenses that could also be considered. They are related to entertainment, gifts or holidays.

Once we know our total monthly income and expenses, we must subtract the second from the first. We must multiply the result by 40% to give us the amount that we can use to borrow money. The formula would be:

Borrowing capacity (BC) = Total income (TI) - fixed expenses (FE) x 0.40