When applying for a home mortgage, two of the primary financial figures a lender will use to determine your level of risk as a borrower are your credit score and your debt-to-income (DTI) ratio.

Most people tend to believe that qualifying for a mortgage is all about your credit score, but that is incorrect. Your DTI is a major influence on a lender’s decision concerning your ability to repay the money that you borrow.

DTI Explained

Your DTI is the percentage of gross income that you pay toward debt commitments each month. The more debt payments you have each month, the higher you DTI is going to be. Of course, your goal should be to keep your DTI as low as possible. Typically, lenders require DTI to be around 36% or lower, but this figure can vary based on the specific loan for which you are applying. If a person has taken out small business loans in their own name, these will also be added to total monthly debt payments.

DTI Calculated

Let’s break down an actual example. Bob is a graphic designer. Bob graduated from college 5 years ago, and has been consistently moving up at his company. Currently, he earns an annual salary of $45,000. Bob’s wife stays home with their 2 small children, so Bob’s total household income each month is $3,750.

Bob has several forms of debt he pays off each month:

• $200 car payment
• $150 school loan payment
• $125 credit card debt

Bob’s total debt payment each month is $475. Right now, Bob’s DTI is only 12.6% ($475/$3,750), which is quite impressive for most lenders. The challenge, however, is that banks are not concerned with your current DTI. They will now factor in what type of loan you can qualify for based on your new monthly mortgage payment. In our example, Bob’s monthly mortgage payment, must be added to his existing debt payments, and this total must remain under the DTI threshold the bank requires for the loan that Bob is applying for.

36% DTI

Let’s assume in our hypothetical example that Bob is applying for a loan that requires the borrower to remain under the 36% DTI threshold. 36% of Bob’s total monthly income ($3,750) equals $1,350. This means that Bob will be able to take on a max $1,350 mortgage payment and stay under the banks DTI requirement. This is fantastic news for Bob because a mortgage payment of $1,350 means that Bob will most likely be able to move into a very nice home.