What is borrowing capacity

Ah, borrowing capacity, that elusive financial metric that makes you wonder if you can afford another gourmet coffee or maybe a new yacht. In the world of finance, borrowing capacity is much more than counting your credit card collection. It's the holy grail that determines how much you can borrow without diving into a sea of debt.

For investors, understanding this capacity is vital, whether you're a beginner or trading on NASDAQ while eating your morning cereal. This capacity not only indicates how much you can borrow but also how much you should borrow. Because, come on, do you really need that ludicrous level of leverage?

The key is to analyze your income, assets, and yes, your bad spending habits. Borrowing capacity is generally measured as a ratio or percentage. This means that if a financial entity tells you that you have a borrowing capacity of 30%, it does not mean they are giving you a VIP pass to spend a third of your income. Instead, it is an indication of how much of your income you can use to pay off debt.

Knowing your borrowing capacity is crucial, especially if you are planning to invest in the stock market. Underestimating your capacity can leave you vulnerable to market changes; while overestimating it can lead you to a financial situation akin to a movie archetype where the protagonist is literally broke.

Now, logically, not everything is black and white. There are strategies to improve and manage your borrowing capacity. Let's take a brief journey through the essential elements you need to smartly bluff when talking about debt at your next cocktail party.

• Stable income: First things first, you need to make sure your income is consistent. Even though being a TikTok influencer may seem secure, financial institutions prefer something a bit more traditional.

• Low level of current debts: Keeping your current debts in check improves your credit profile, and hence, your capacity.

• Impeccable credit history: Being punctual with your payments is not only polite but also positively affects your borrowing capacity.

Key Formulas

Numbers don't lie, folks. It's time to dust off your calculator and get to work calculating your borrowing capacity with some key formulas, which would surely make even Einstein raise an eyebrow.

Okay, you don't need a PhD to understand this. Those who did probably are just trying to impress their parents. However, here are some basic formulas so you can surprise your friends in financial talks (or at least yourself):

1. Debt-to-Income Ratio (DTI): This is the knight in shining armor of financial formulas. Calculate by adding all your monthly debt obligations and dividing it by your gross monthly income. Multiply it by 100 and you will get your percentage:

(Monthly Debt Obligations / Gross Monthly Income) x 100 = DTI%

A low DTI suggests you're managing your debts well. Financial institutions generally prefer a DTI below 36%.

Monthly Payment Capacity: For a deeper dive, you can analyze monthly payment capacity using the formula:

Monthly Income - Fixed Expenses = Monthly Payment Capacity

This formula is great for identifying how much you can really afford to allocate to the payment of new debts.

Use of Credit Lines: Yes, yes, that card you've been using to buy new clothes counts as debt. Calculate the use of credit lines by dividing your credit card balance by the total credit limit and multiplying it by 100.

(Credit Card Balance / Total Credit Limit) x 100 = Credit Use%

This will give you an idea of how much of your borrowing capacity is occupied with "revolving debt".

In summary, managing these formulas will not only help you have a clear view of your borrowing capacity, but it might also impress your boss when you request a raise (now with well-supported numbers, of course).

Practical Example

Let's talk about a practical example, because without examples, this would be like an IKEA instruction manual without pictures. Imagine Carla, a fierce 32-year-old investor, has decided to take the plunge into the world of trading. Not content with simply buying trendy stocks, she wants to maximize her potential by using loans.

Carla earns $6,000 a month. After covering her fixed expenses, including mortgage, utilities, and other debts, she has $3,800 left over each month. The million-dollar question is: what is her borrowing capacity?

Calculating the DTI: Let's say her monthly debts included a $300 student loan and an incredibly reasonable $200 car payment. Adding a credit card that costs her $100 each month, her total monthly debt obligations are $600.

DTI% = ($600 / $6000) x 100 = 10%

With a 10% DTI, Carla is exceptionally below the preferred threshold for lenders of 36%.

Monthly Payment Capacity: Carla has $3,800 available for more debt adventures. This amount would allow her to take on new obligations while maintaining a safe financial cushion.

With a well-managed DTI and a healthy capacity to incur new debts, Carla can explore riskier investment options, like margin trading, as long as she keeps a careful watch on her risk levels. She could be the next star of a financial success documentary. Or the next WallStreetBets meme, depending on how her story unfolds.

Remember, as Benjamin Franklin once said: "He who buys what he does not need, must soon sell what he needs." So, make calculated decisions and keep your borrowing capacity well monitored. Happy trading, and may the profits always be in your favor.