How to Calculate How Much You Can Borrow
Whether you are buying a car or a house, or making a significant business purchase, taking the time to calculate how much you can borrow can help you avoid dangerous debt situations while also allowing your full spending capacity. The variables you will need to know before beginning are the current interest rates, the number of months of the loan period, and the amount you can afford each month for the loan payment.
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Instructions
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The Formula
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Research the current interest rates for the type of purchase you wish to borrow for, such as auto, home, or business. Divide the annual interest rate by 12 and call this figure "R." R should be expressed as a decimal. For example, a home loan rate of 6 percent divided by 12 would give the formula: 0.06/12 = 0.005. In this example, R = 0.005.
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Calculate the number of months for the loan period. An average mortgage lasts 30 years, or 360 months, while an average auto loan ranges from 3 to 5 years, or 36-60 months. Call the number of months figure "M."
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Determine the amount you can afford to pay toward your monthly payment. Call this figure "L."
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Now, determine the maximum amount you can borrow (figure "B") by computing the following equation:
B = [L/R] x [(1+R)^M - 1]/[(1+R)^M]
Note that the symbol ^ denotes that M is the exponent. Look for the 'x^y' button on your calculator.
For example, if you want to take an auto loan of 60 months at 6 percent interest and you can afford a $300 payment each month, then your calculation would look like this:
B = [300/0.005] x [(1 + 0.005)^60 -1]/[(1 + 0.005)^60]
B = 60,000 x [(1.005)^60 -1]/[(1.005)^60]
B = 60,000 x [0.34885]/[1.34885]
B = 60,000 x 0.25862
B = 15,517.66
In this case, at the rate of 6 percent for 60 months and a monthly payment of $300, you could borrow $15,517.66 toward your car purchase.
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Tips & Warnings
Make sure to factor a monthly payment that you can truly afford to pay each month for the duration of the loan. If it is a lengthy loan term, consider what will happen if you need to move or change jobs in the middle of the loan.
References
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