When applying for a VA home loan, borrowers hear a lot about something called debt-to-income ratio.
Debt-to-income ratio (DTI) is an underwriting guideline that compares a borrower’s monthly debt payments to gross monthly income and helps lenders determine if you meet VA loan qualifications. VA lenders look for a DTI of 41 percent but evaluate it a bit differently than the other major lending avenues (FHA, USDA, conventional). VA lenders consider only 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 calculate 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 respectively. The VA considers only the back-end ratio.
VA & Lender Benchmarks for Debt-to-Income 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.
Again, the VA uses a DTI benchmark of 41 percent. 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.
Different lenders can have different caps on DTI ratios. Some might push beyond 50 percent or more, depending on the strength of your other financial and credit factors.
Veterans with a DTI ratio above 41 percent must also meet a higher residual income requirement. That’s a separate income-related standard we cover elsewhere (See: Explaining the VA’s Residual Income Standard).
Calculating Your VA Loan Debt-to-Income Ratio
Your backend DTI ratio is calculated by taking your major monthly debts (many of which will be found on your credit reports) and dividing it by your gross monthly income. Here’s a quick example:
- Divide your $60,000 salary by 12 to find your gross monthly income ($60,000/12 = $5,000)
- Your monthly income is $5,000
- You spend $500 monthly on a car loan, $1,000 for your new mortgage and $550 for your other debt obligations, which totals $2,050 in monthly debt and expenses
- Take that $2,050 and divide it by $5,000 (monthly debt divided by monthly income)
- $2,050/$5,000 = 41 percent debt-to-income ratio
Remember: DTI ratio is calculated using your pre-tax, or gross, income.
As you can tell from the formula above, having a lower debt-to-income ratio may indicate a healthier financial status overall. A high DTI could be a sign that borrowers might be stretched too thin financially with the kind of mortgage payment they’re considering. But it’s not always that clear cut.
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 commission, 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.
Surprised that your DTI is higher than expected? If you have debt or credit issues, the team at Veterans United’s Lighthouse program specializes in strengthening financial profiles prospective homebuyers with no charge or obligation.
Here’s a look at some of the types of income and debts that could be included in your DTI ratio calculation.
What’s Included in A VA Loan DTI Ratio
Possible Income (before taxes)
- Monthly income
- Rental income
- Investment income
- Alimony (included in income and debt)
- Child support payments (included in income and debt)
- Current mortgage payment
- New mortgage payment
- Car payment
- Student loan debt
- Minimum credit card payments
- Childcare or alimony
- Co-signed loans
Not Typically Included in Debt
- Utility payments
- Household expenses
VA lenders will use your DTI, your residual income and other factors to get a solid overall picture of your ability to handle a mortgage payment.
Also keep in mind that DTI ratio is just one number. Your credit score, your residual income and other financial requirements will all come into play when you’re pursuing a VA home loan. In addition, having a sky-high DTI ratio doesn’t automatically put an end to your homebuying dreams.
But you may have to lower your sights a little bit.
For more help determining what’s included in your specific debt-to-income ratio, call 1-800-884-5560 to speak with a VA loan specialist.
Tweak the Numbers
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 for VA lenders nationwide.
If you’re ready to move forward with the VA loan process and still have questions about your specific financial situation, make sure you’re in the hands of an experienced lender. Get started online today.
Photo courtesy of 410(K) 2012