What is a Borrowing Base?
A borrowing base is a collection of assets that are used to secure a loan. Lenders base the amount of money they are willing to offer on the borrowing base, making this amount very important for both lenders and borrowers. When a lender decides to offer credit or a loan, it makes a borrowing base calculation using a formula contractually agreed to by lender and borrower to determine how much money should be offered. This formula also allows for adjustments to revolving lines of credit in the event that there is a change in circumstances for the borrower.
The borrowing base includes any assets that the borrower has, including assets that are pledged as collateral on the loan. It is determined by reviewing the application filed by the borrower. Borrowers are expected to list assets, liabilities, and income. They must also provide information such as disclosures that assets are already pledged as collateral on other loans, the source of their income, and so forth. All of this information is used with the borrower's credit history to determine the credit risk posed by lending to the applicant.
To calculate the amount it wants to lend, the lender multiplies the borrowing base by a discount. The discount is determined by the credit risk. High risk loans will have a higher discount, reflecting the lender's concerns about getting repaid in full. Lower risk loans have a lower discount, because the lender is more confident that the loan will be paid off.
In a simple example, if someone has a borrowing base of $100,000 United States dollars (USD) and is considered low risk, the lender might decide that the discount should be 85%, and offer $85,000 USD in loans to the borrower. A higher risk borrower might be offered a loan of $60,000 on the base of the borrowing base and credit history. This process is known as margining, and every lender has slightly different ways of determining the percentage of the discount.
People who want to apply for loans can estimate their borrowing base and obtain their credit score to learn more about what kinds of loans might be available to them. Working with a broker can be helpful, as brokers may be able to negotiate better deals than people can get on their own. Brokers also have a great deal of experience and can provide people with tips to reduce their credit risk to bolster a loan application.
@indemnifyme - Banks seem to be all about minimizing their own risk, that's for sure! But, there is one flaw in those formulas, as least for the customer: if you had the money, why would you be borrowing the money?
For example, a person who is trying to get a loan to buy a house doesn't have a house to put up as collateral, you know? I guess my point is that everyone has to start somewhere, so banks should make some kind of allowances for that.
The idea of using my assets (what few I have) to secure a loan makes me nervous. I'm pretty sure that means if you default on a loan they take the assets you used to secure the loan to make up for it!
That being said, I totally understand why banks do this. Lending someone money is a risk, so it makes sense to find out if they have something of equal value to give to you if they can't pay.
@chrisinbama- I completely understand what you're talking about. When we attempted to purchase a house last year, I felt as though I was being interrogated. We were supposed to list everything that was considered an asset. It was so frustrating because things that we considered just "stuff", they considered an asset.
After it was all said and done, we were only offered 65% of what we needed. We could not come up with the other 35% so we are still renting.
I don't really have a lot of knowledge in the area of banking but this was very interesting to read. I've often wondered where creditors come up with the amounts that they will allow you to borrow.
A few years ago, I was laid off from my job and I got behind a couple of payments on my car. I finally caught it up but my credit score went down. The next time I tried to get a loan, they would only loan me about half of the amount I needed. During these economically challenging times, that will probably happen to a lot more people.
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