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An advance rate is a percentage of the value of an asset that a lender will utilize to determine the amount of a loan or line of credit for a borrower. Typically, the lender will assess the overall financial condition of the borrower, taking into account the ability to repay the loan according to the standard terms and conditions. After confirming the current market value of the asset offered as collateral, the lender will then notify the borrower of his or her current advance rate and the maximum amount that can be borrowed. This approach helps to minimize the risk taken on by the lender, as the collateral is likely to be sufficient to recoup the debt in the event of default.
While advance rates are based heavily on the value of the asset that the borrower wants to pledge, lenders will also consider other relevant financial information. This includes identifying the applicant’s current credit rating, level of income, and the ratio of that income to other debt obligations that may exist. If the lender determines that the applicant is creditworthy, and has the ability to consistently make monthly payments on the loan, the process moves on to appraising the value of the asset that is being offered as collateral.
Once the value of the collateral is established, the lender sets the percentage of that value as the highest amount that the lender is willing to extend as part of the loan or line of credit. For example, if the lender determines that the borrower’s advance rate is 80%, and the pledged asset has a current market value of $1,000.000 US Dollars (USD), the maximum amount that the lender will approve is $800,000 USD.
The application of an advance rate is in the best interest of both parties. For the lender, this process helps to increase the chances of earning a return on his or her investment in the borrower, even if the loan eventually goes into default. At the same time, the borrower has the benefits of receiving more competitive interest rates than would be possible with an unsecured loan, and is in less danger of overextending his or her finances, assuming the borrower was diligent in the calculation of the advance rate. With the use of the advance rate as the basis for the lending activity, the potential for both parties to receive what they want from the business relationship is greatly increased.