Definition
A consumer’s capacity refers to their ability to afford debt payments. Capacity is a measure of an individual or business entity’s discretionary income, which is sometimes calculated from their debt-to-income ratio.
Analysis
While a lender will evaluate an applicant’s predicted risk of default by examining their credit score, they also will determine the applicant’s capacity to repay the debt. They do this by requesting income amounts and sources, and by evaluating the applicant’s overall indebtedness.
Some amounts may not require verification, depending on the type of loan or credit account. Other amounts, such as debt payments may be obtained through a credit check in order to determine estimated monthly cash outflows.
An applicant with a high capacity for repayment would have above average income and below average monthly debt payments. Capacity ignores credit scores, and is a measure of the person’s financial strength. Most lenders will base their credit granting decisions on both estimated capacity and creditworthiness.
