What size loan can you afford?

There are various types of loans on the financial market and each type has some defining traits, be they interest rates, maximum amount borrowable or maturity periods. Determining the right size of a loan is indubitably a highly individual issue, since people use loans for a host of purposes. However, there are some principles which are universally applicable and can serve as a great starting point for choosing your appropriate loan amount.

Examine the purpose of your loan

First and foremost, you need to have a clear understanding of why you want to borrow new funds. Is it to buy something new for your house? Cover medical expenses? Invest into expanding your small business? This is something that you as a future borrower need to determine and the way to do it is by approaching the subject analytically and honestly.

The purpose of the loan gives you the foundation on which you’ll develop your borrowing plan. See how much of this required amount you can finance on your own and then calculate how much more you’d have to borrow in order to complete your necessary budget.

Loan type and conditions

Different types of loans are designed for different purposes and their maximal effectiveness is determined accordingly. Once you’ve decided on the purpose of the loan, be sure to check out all the available loan types which you could apply for. Each loan type comes with its own eligibility criteria and conditions, so you’d be wise to do a comparative analysis of your options. There are plenty of free calculators available on the web, so you can get an estimated cost of your loan and its basic preferences, at the very least.

Analyze your income

After you’ve established why you need the money for and what type of loan suits you best, you need to look at potential limitations. The size of your loan should be primarily defined by one factor – your disposable monthly income. It’s important to accurately assess your monthly cash flow and deduce how much money you will be left with after you’ve paid for all your regular expenses. Typically, this remaining amount is the approximate ceiling for your potential monthly loan repayment.

Assess your collateral

There are collateralized (secured) and non-collateralized unsecured loans – think mortgages and payday loans respectively, for example. Having collateral when applying for a loan directly impacts the total of amount of money you can get from most lenders in a very basic way - high value collateral almost always means more funds available for borrowing. However, since your debt repayment is a function of you income, keep in mind that this collateral will be claimed by the lender should you default on your debt. Try to avoid putting down high value collaterals as a guarantee for your loan if you’re unsure about the level and certainty of your future income.