When applying for a VA home loan, borrowers hear a lot about something called debt-to-income ratio.
It’s an important tool that plays a key role in determining what kind of VA loan, if any, you can secure.
In essence, debt-to-income ratio, or DTI ratio, compares a borrower’s total monthly debt payments to his or her gross monthly income. The world of VA lending looks at DTI a bit differently than the other major lending avenues (FHA, USDA, conventional), in that the agency only cares about one ratio, which factors in all of the borrower’s monthly debt, from housing costs and revolving debts to anything else that’s pertinent.
The other major loan options tend to favor two separate DTI ratios, one solely for housing expenses and a second, holistic tally. You might hear them called front-end and back-end ratios. The VA considers only the back-end ratio.
In general, the higher the ratio, the more likely that your monthly expenses will outstrip your monthly income. That’s a red flag for lenders who are constantly on the lookout for warning signs and potential indicators of mortgage default.
The VA uses a DTI benchmark of 41 percent, which is higher than what you’ll find with conventional and even FHA financing.
But prospective borrowers with a debt-to-income ratio above that threshold shouldn’t immediately resign themselves to renting. A DTI ratio greater than 41 percent triggers additional layers of fiscal scrutiny, but it doesn’t automatically disqualify you from obtaining a loan.
Veterans with a DTI ratio above that threshold have to meet a higher residual income requirement. That’s a separate standard we cover elsewhere (See: Explaining the VA’s Residual Income Standard).
There’s also another approach prospective borrowers can take if their DTI ratio is a bit too high: Try a lower loan amount.
That’s exactly what the loan officer will do. If a $250,000 loan looks to be a bit too much for the veteran, the lender can essentially just play with the numbers until they become workable. Instead of $250,000, maybe try $225,000 or $215,000. This kind of plug-and-play with loan amounts is standard fare for lenders nationwide.
Sure, it’s disappointing when veterans discover the $250,000 house they’ve been eyeing for months isn’t really in their price range. But a $215,000 house is better than none at all. And, of course, the other option is for prospective borrowers to tackle their credit and financial issues first and hold off on purchasing a home.
Photo thanks to Tim via Flickr Creative Commons