When it comes to getting a VA home loan, one of the key financial metrics for lenders is debt-to-income (DTI) ratio.
The debt-to-income ratio is an underwriting guideline that looks at the relationship between your gross monthly income and your major monthly debts, giving lenders insight into your purchasing power and your ability to repay debt.
Some loan types require a look at two forms of DTI ratio -- a "front-end" one that looks at the relationship between your gross monthly income and your new mortgage payment, and a "back-end" ratio that considers all of your major monthly expenses.
For VA loans, lenders consider only the back-end ratio, which offers a more holistic look at your monthly debt-and-income situation.
The VA views DTI ratio as a guide to help lenders, and it doesn’t set a maximum ratio that borrowers must stay under. But the VA doesn’t make home loans, and mortgage lenders will often have in-house caps on DTI ratio that can vary depending on the borrower’s credit, finances and more.
Let’s take a closer look.
Calculating DTI Ratio for a VA Loan
Only certain types of debts and income count toward your DTI ratio.
Lenders will consider your major revolving and installment debts, mostly pulled directly from your credit reports. These are expenses like mortgages, car loans, student loans, credit card debt and more. But lenders can also consider obligations that don’t make your credit report, like child-care costs, alimony and even commuting expenses.
If you have collections or charge-offs on your credit report, lenders won’t typically factor those into your DTI ratio calculation unless you’re making regular monthly payments on those debts.
But lenders may have a cap on how much of this derogatory credit you can have. Guidelines and policies can vary by lender.
The biggest debt is likely to be your projected monthly mortgage payment, which will include the principal and interest on the loan along with estimated escrow amounts for property taxes and homeowners insurance. On VA loans, lenders will also include an estimated cost for monthly utility bills, multiplying the home’s square footage by 0.14.
Lenders will add up these debts and divide them by your gross (pre-tax) monthly income. The VA allows lenders to “gross up” tax-free income to create a pre-tax figure for the purpose of calculating DTI ratio.
Here’s an example of how to calculate DTI ratio, assuming the borrower has a gross monthly income of $5,500:
|Car loan =||$200|
|Student loan =||$150|
|Credit cards =||$100|
|Child care/child support/alimony =||$300|
|New mortgage payment (PITI) =||$1,200|
|Estimated utility costs =||$200|
|Major monthly debts =||$2,150|
|Gross monthly income =||$5,500|
|DTI ratio =||39% ($2,150 / $5,500)|
It’s also important to understand that mortgage lenders don’t consider all income equally. Some forms of income will count toward qualifying for a mortgage with no problem. But other forms, like overtime, self-employment income and others, will often require at least a two-year history. And some forms of income, like GI Bill housing allowances, simply won’t be counted as effective income toward a mortgage.
Lenders don’t count all your debts, either. Things like cell phone bills, car and health insurance, groceries and other expenses aren’t factored into this calculation.
Calculating your DTI ratio is one step. But the question is: How does that number affect your ability to land a VA home loan?
VA and Lender DTI Benchmarks
Lenders can set their own benchmarks for maximum allowable DTI ratio. Those caps can vary based on a host of factors, including the presence of compensating factors and whether the loan file needs to be underwritten manually.
Some lenders might allow a DTI ratio above 50 percent -- even well above it, in some cases -- depending on the strength of the borrower’s overall credit and lending profile.
While the VA doesn’t mandate a maximum DTI ratio, it does set a dividing line for prospective borrowers. Veterans and military members with a DTI ratio above 41 percent will encounter additional financial scrutiny.
In these cases, borrowers will get an up-close look at the link between DTI ratio and the VA’s guideline for discretionary income, known as residual income.
DTI Ratio & Residual Income
The residual income guidelines require borrowers to have a minimum amount of discretionary income leftover each month after paying major expenses. The minimum amount varies depending on your loan amount, your family size and where in the country you’re buying.
For example, a Midwestern family of four would typically need $1,003 in residual income each month after paying their mortgage and other major debt obligations.
But VA buyers need even more residual income on hand if their DTI ratio is higher than 41 percent. These borrowers will need to exceed their residual income guideline by 20 percent in order to satisfy the VA and lenders.
If our example Midwestern family of four has a DTI ratio above 41 percent, here’s what their residual income requirement would look like:
$1,003 x 20 percent = $200
$1,003 + 200 = $1,203
Our example family of four would need $1,203 in residual income every month to keep their loan moving forward, at least at the current loan amount.
And that’s also something to keep in mind: A huge piece of your DTI ratio is your projected monthly mortgage payment.
Dealing with High DTI Ratio
Having too high of a DTI ratio can force borrowers to make tough decisions.
One is to hold off on buying a home until they have a better balance of debts and income. Another option is to seek a lower loan amount.
For example, if your DTI ratio is too high with a $300,000 loan, you might be able to move forward with a $250,000 mortgage. Readjusting your homebuying budget is often disappointing, and it might not be realistic depending on your real estate market, your needs and other factors. But it’s an option for dealing with a high DTI ratio.
Talk with a Veterans United loan specialist if you have questions about your debts, your income and your purchasing power.