Lesson 12 of 20 · 6 min
A rate change is not a capacity change
Two independent numbers govern a line, and a change in one implies nothing about the other.
This lesson separates two things that both feel like the size of your line and are governed by completely different mechanisms.
The rate determines the cost of what you have drawn. It comes from index plus spread, moves with markets and with lender pricing decisions, and appears on every statement. Capacity determines how much you may draw. It comes from market value times advance rates, moves with prices and with policy revisions, and typically appears nowhere.
The two are not linked in either direction. A rate increase does not reduce capacity. A capacity reduction does not change the rate. And a facility can have plenty of capacity and be near its maintenance threshold at the same time, because capacity is measured against a percentage of collateral value while the threshold is measured against the balance — including accrued interest.
The distinction matters most in one specific situation. A borrower who receives a notice about a rate change may reasonably assume it is the only thing that changed, and it may not be — an advance rate revision, which affects capacity and headroom, might arrive in the same period with no notice at all. Checking one figure and inferring the other gives a false picture of both.
The clean way to hold it: rate is a price, capacity is a limit, and headroom is a distance. Three separate quantities, three separate sources, and only the price is printed reliably.
Key terms
- Rate
- The price of the drawn balance. Index plus spread, printed on statements, changeable by either component.
- Capacity
- The maximum drawable amount. Market value times advance rates, rarely printed, changeable by policy revision.
- Headroom
- The distance to the maintenance threshold. A function of the balance, collateral value and the threshold — independent of both the rate and capacity.
Worked example
Three numbers moving independently
Market value $600,000, blended advance rate 70% (so collateral value $420,000), balance $250,000, threshold 70% of collateral value, rate 6.85%. Trigger collateral value $357,143.
- Starting: rate, capacity, headroom
- 6.85%, $420,000, 15.0%
- Rate rises to 7.85%
- Capacity $420,000, headroom 15.0%
- Advance rate cut to 60% instead
- Capacity $360,000, headroom 0.8%
- Or the market falls 15% instead
- Capacity $357,000, headroom 0.0%
- Number of these events printed as a notice
- Typically one
- Which one
- The rate change
Neither moved.
Rate unchanged.
At the trigger.
The event most likely to be announced is the one with the least effect on whether a call arrives.
Check yourself
You receive a notice that your rate has risen one point. What does that tell you about your capacity and your headroom?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.