Also called the loan principal, the loan amount is the monetary amount of credit or financing provided to a borrower.
For most installment loans, the loan amount typically refers to the starting principal balance of the provided loan. Each installment payment made by the borrower will usually reduce the loan’s principal balance (or remaining loan amount), unless additional fees are assessed or the loan is an interest-only financing program.
Formal loans, particular from banks, credit unions, financing companies and other institutions, are typically established with a loan agreement, promissory note or loan contract. In addition to clarifying the loan principal amount, this financing contract will also describe the terms of the loan and the obligations of the parties to the loan. One of the most important obligations, from the lender’s point of view, is the borrower’s obligation to repay the loan principal – with applicable interest and finance charges.
Along with interest rate and loan term, the loan amount is one of the three elements used to determine monthly payments for installment loans. Whether it’s for a car loan, mortgage financing or personal loan, most installment loan providers use these three elements to determine the amortized monthly payments for the loan.
Qualifying for a (higher) loan amount
When shopping for a consumer loan, many individuals will already have a loan amount in mind. One of the important questions answered by the lender’s application and underwriting process is whether the borrower can qualify for that target loan amount.
Depending on the loan program and lender guidelines, a borrower’s loan amount qualification is often determined by the following elements:
- Income qualification. For many lenders, the most important factor for determining the loan amount a borrower can qualify for is income. Lenders want to be sure that borrowers can afford to repay the loan amount being borrowed, and the borrower’s documented income is a popular measurement of the borrower’s ability. To qualify for a higher loan amount, the borrower will need to document sufficient or more income. As an alternative, the borrower may also add a co-signer with strong income qualification. [Note: that with some low-income loans or student loans, these income qualification guidelines may be relaxed or waived.]
- Debt load. Related to the above income qualification section, some lenders will look at the borrower’s overall debt load to see how much the borrower can actually afford to pay on a new loan. If the borrower seems to carry a heavy debt load or high debt-to-income (DTI) ratio, lenders may approve a much lower loan amount… or no loan at all. Borrowers in this situation may need to pay down or consolidate their debt loads in order to qualify for a higher loan amount.
- Value of collateral. With secured loans, the loan amount is typically limited to a percentage of the value of the collateral being used as security for the loan. For example, with most mortgage and automobile loans, the loan amount approved by the lender will be limited to a portion of home value, car value or purchase price. If the approved loan amount is less than the purchase price or value of the collateral, the borrower will have to make up the difference with a down payment. As an alternative, some home and car buyers may negotiate with the seller to reduce the purchase price or assist the buyer with some of the costs. With borrowers considering a secured title loan on a vehicle with insufficient value, one option is to consider personal unsecured loans, which may be able to provide a higher loan amount – without using the vehicle’s value and title as collateral.
- Program limits. Many lenders and loan programs have minimum and maximum loan limits, regardless of borrower eligibility. So even if a loan applicant can qualify for a loan amount that is below the minimum loan level or above the maximum loan level, that borrower may not be able to obtain that loan amount. For example, some consumer loans may have a minimum loan requirement of $4,000. Even if the borrower is able to qualify for a $3,000 loan, the lender may not be able to provide the financing that borrower requires – unless the borrower can qualify for and accept a higher loan amount. Depending on the borrower’s situation, they may have to look for a different loan program.
- Credit. In some cases, the maximum loan amount that a program may offer to certain borrowers will be determined by that borrower’s credit record or score. Lenders may lower the loan amount for borrowers with damaged credit histories or low credit scores so as to limit the lender’s risk exposure. For borrowers in this situation, the clear answer is to improve one’s credit ratings and scores. That may be challenging, if nearly impossible, for many borrowers with severely damaged credit.
Selecting the right loan amount
With many consumer loans, the lender, creditor or financing company will often approve the borrower for a maximum loan amount. However, the borrower does not have to take the full approval amount.
When deciding on the loan amount to choose for any loan, individuals should consider how much debt they feel comfortable carrying for the term of the loan. A higher loan amount will mean higher loan payments.
Even though the lender’s underwriting guidelines determine that the borrower can afford the new loan, keep in mind that that is the lender’s perspective. Before making a final decision on loan amount, borrowers will need to balance what they need and what they believe they can afford to borrow.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.
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