Lenders evaluate borrower creditworthiness using several quantitative measures that determine both approval and pricing. The credit score is the most familiar; higher scores generally qualify borrowers for lower interest rates, and a difference of just 100 points can change a mortgage rate by 0.5% or more, equating to tens of thousands of dollars in interest over a typical 30-year loan. The debt-to-income, or DTI, ratio compares monthly debt payments to gross monthly income, calculated as \[\text{DTI} = \frac{\text{Monthly Debt Payments}}{\text{Gross Monthly Income}} \times 100.\] Lenders typically prefer DTI below 36%, with 43% as the maximum for qualified mortgages under standard guidelines.
For mortgages, lenders also look at the loan-to-value, or LTV, ratio, which compares the loan amount to the property's appraised value: \[\text{LTV} = \frac{\text{Loan Amount}}{\text{Property Value}} \times 100.\] Higher LTV means greater lender risk, and LTV above 80% typically triggers a requirement for private mortgage insurance. When multiple loans are secured by the same property, the combined loan-to-value, or CLTV, ratio sums the balances of all liens and divides by the property's value. CLTV measures total lien exposure and is used to evaluate risk when a primary mortgage coexists with a second mortgage or HELOC on the same property.
Risk also shows up in pricing through the credit spread, the additional interest rate a borrower pays above a benchmark rate such as prime or Treasury yield to compensate the lender for credit risk. Borrowers with weaker credit pay wider spreads above the base rate. The benchmark rates themselves are anchored to broader policy: the federal funds rate is the rate at which US banks lend reserves to each other overnight, set by the Federal Reserve's Federal Open Market Committee, and it influences virtually all other rates in the economy, including mortgage rates and credit card APRs. Beneath all of these measures sits the fundamental lender concern that the borrower can repay from sustainable cash flow, which is why debt service, the total cash required each period to cover interest and principal, is monitored through the debt service coverage ratio in commercial lending, \[\text{DSCR} = \frac{\text{Net Operating Income}}{\text{Debt Service}},\] with lenders generally requiring DSCR of at least 1.2.