How do you calculate the maximum loan a borrower can receive?

The maximum loan a borrower can receive is calculated by dividing the annual debt service cost by the loan factor. This method primarily focuses on understanding the relationship between the borrower’s capacity to pay and the terms of the loan.

The loan factor represents the cost of borrowing for a specific loan amount, considering the interest rate and loan term. By dividing the annual debt service (the total amount a borrower must pay annually, including both principal and interest) by the loan factor, one can derive the maximum loan amount that a borrower can comfortably afford based on their payment capabilities.

This approach allows lenders to evaluate if a borrower’s income and financial obligations support obtaining a loan of a particular size, ensuring that the borrower does not face financial strain from loan repayments.

In contrast, other methods, like multiplying annual income by the loan factor or adding annual expenses to the loan factor, do not accurately reflect the borrower’s ability to manage debt based on payments required. Thus, using the annual debt service cost in relation to the loan factor gives a clearer picture of what is feasible for the borrower.