Before house hunting, the first question to answer is: how much can I borrow? The answer depends on your debt-to-income ratio.
The Debt-to-Income Ratio (DTI)
Definition
DTI measures the share of your income that goes toward debt payments:
DTI = (Total Monthly Debt Payments / Gross Monthly Income) × 100
The 43% Rule
Most lenders cap DTI at 43% for qualified mortgages. Some allow up to 50% with strong compensating factors.
| Gross Income | Max Payment (43%) | Max Payment (36%) |
|---|---|---|
| $4,000 | $1,720 | $1,440 |
| $6,000 | $2,580 | $2,160 |
| $8,000 | $3,440 | $2,880 |
| $10,000 | $4,300 | $3,600 |
Lenders distinguish between front-end DTI (housing costs only, typically ≤28%) and back-end DTI (all debts, typically ≤43%).
What Counts as Income?
| Income Source | Counted? |
|---|---|
| W-2 salary | ✅ Full amount |
| Self-employment income | ✅ 2-year average |
| Rental income | ✅ 75% (vacancy discount) |
| Bonuses/commissions | ✅ 2-year average |
| One-time windfalls | ❌ No |
| Child support received | ✅ If documented |
| Investment income | ✅ If consistent |
What Debts Are Included?
- All monthly loan payments (mortgage, auto, student, personal)
- Minimum credit card payments
- Child support / alimony payments
- The proposed new mortgage payment
Regular expenses (groceries, utilities, insurance) are not included in DTI calculations.
Calculating Borrowing Capacity
Borrowing capacity depends on three factors:
- Maximum monthly payment (based on DTI)
- Interest rate
- Loan term
Capacity Table
For a maximum payment of $2,000 (gross income ~$4,650):
| Term | Rate | Borrowing Capacity |
|---|---|---|
| 15 years | 6.5% | $228,000 |
| 20 years | 6.75% | $275,000 |
| 30 years | 7.0% | $301,000 |
Add a $40,000 down payment and the total home budget becomes $341,000 (on 30 years) - minus closing costs (~$10,000).
Residual Income
Beyond DTI, lenders also look at residual income - what's left after all debt payments:
Residual Income = Gross Income - Taxes - Debt Payments - Living Expenses
VA loans explicitly require minimum residual income based on family size and region.
| Income | Payment (43%) | Remaining |
|---|---|---|
| $5,000 | $2,150 | $2,850 |
| $8,000 | $3,440 | $4,560 |
| $12,000 | $5,160 | $6,840 |
How to Increase Your Borrowing Capacity
1. Pay Off Existing Debts
A $400/month car payment reduces your borrowing capacity by ~$60,000. Pay it off before applying for a mortgage.
2. Extend the Loan Term
Going from 15 to 30 years increases capacity by ~32%, but costs significantly more in interest.
3. Increase Your Down Payment
More down payment = less to borrow = lower monthly payment.
4. Add a Co-Borrower
A co-borrower's income adds to yours, increasing total capacity.
5. Improve Your Credit Score
A higher score (740+) qualifies you for better rates, which stretches your borrowing capacity further.
6. Reduce Credit Card Balances
Even if you pay in full monthly, high balances on statement dates inflate your DTI. Pay them down before applying.
Traps to Avoid
Borrowing the Maximum
Just because a lender approves $350,000 doesn't mean you should borrow that much. Keep a margin for emergencies, maintenance, and life changes.
Forgetting Ancillary Costs
Beyond the mortgage payment, budget for:
- Property taxes
- Homeowner's insurance
- HOA fees
- Maintenance (1-2% of home value/year)
Making Major Purchases Before Closing
Don't buy a car, furniture, or anything on credit between pre-approval and closing. New debt can disqualify your mortgage.
Conclusion
Your borrowing capacity is the starting point of any home purchase. Calculate it precisely, optimize your profile (pay off debts, save for a down payment, boost your credit score), and always keep a safety margin below the maximum.