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Debt capacity: explanations and hints

Blog | Credit

What is the debt capacity?

Before issuing a credit the bank monitors the debt capacity, also called borrowing capacity. The debt capacity is the maximal amount that the consumer is able to borrow monthly for a credit. It represents the amount that consumers can borrow, including interest rate and credit repayment.

The borrowing capacity states to the lender how much a consumer is able to borrow. This data protects both the bank and the borrower. The bank is sure not to lose money as the borrower is certain to be able to repay. The borrowing capacity may vary from one type credit to another one: a consumer loan is different from a mortage for example.

How to calculate the debt capacity for a consumer credit?

In Swtizerland, the debt capacity for a consumer credit is regulated by the article 28 of the Federal Law on Consumer Credit (FLCC). The capacity to enter a consumer credit agreement is evaluated on the basis of a repayment over 36 months, even if according to the agreement the installments cover a longer period.

What is the line of credit?

The line of credit is the money that a consumer have after the payments of his fixed costs. For example, the fixed costs include the rent, the health insurance, the taxes, the travel costs, the overall spending on children or the credit commitments. The line of credit is different for everyone according to it’s very own situation.

To explain better the line of credit, let’s have a look at a specific example. Someone has a monthly line of credit of 1000.- CHF. It means that this person can repay an amount of 36’000.- CHF in 36 months, according to the article 28 of the FLCC. That person can make a loan of 36’000.-, including the loan and the interest. This example means that the line of credit includes the credit amount and the payment of the interest rate.

The debt capacity for a mortgage

To establish it, the banks take into account the amount of own funds and the debt ratio. The banks initially require a contribution in capital equivalent to minimum 20% of the price of the property. This contribution is called the own funds. Then the debt ratio will be established which is the ratio between the monthly amount of the loan relative to the income. This ratio must be less than or equal to 33% to get a mortgage.

The usefulness of knowing its borrowing capacity

To know its debt capacity is important for a future borrower in order to negotiate his loan terms. It will be the key indicator for the terms and the interest rate of the loan. Indeed the borrowing capacity also indicates the credit risk for the bank. To determine exactly your debt capacity, you can contact our partner Multicrédit, specializing in loans on the best possible terms.

Article written by Mr. Aslan Münur, credit expert at Multicredit.

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