Debt-to-income Ratio for VA Loan

When applying for a VA loan, veterans must understand the debt-to-income ratio. This ratio determines the loan amount and interest rate a VA lender can offer, which is instrumental in purchasing a home.

Understanding the VA loan requirements, qualifying for a VA loan, and working with a mortgage lender can help veterans obtain a monthly mortgage payment that works for them. By working with the Department of Veterans Affairs and understanding loan eligibility, veterans can increase their income and confidently buy homes.

What is the Debt-to-income Ratio on a VA Loan

Debt-to-income ratio (DTI) is a financial metric lender use to determine an individual's ability to repay debt. It measures the amount of debt a person has compared to their income.

To calculate your DTI ratio, you divide all your monthly debt payments (credit card payments, car payments, student loans, and mortgages) by your gross monthly income. The resulting number is your DTI ratio.

For example, if you have $1,500 in monthly debt payments and $5,000 in gross monthly income, your DTI ratio would be 30% ($1,500 ÷ $5,000 = 0.3).

Lenders use the DTI ratio to assess the risk of lending money to a borrower. A higher DTI ratio indicates that a borrower may have difficulty making monthly debt payments. In comparison, a lower DTI ratio indicates a borrower has a more manageable amount of debt to their income.

The Importance of Debt-to-income Ratio

Since there are so many different types of loans available, lenders use this ratio to determine whether they can trust you to pay your bills on time. The lender will look at the total amount of debt you have and the amount of income you have.

The lender will look at the total amount of your monthly income. For example, if you make $5,500 monthly and your total monthly debt payments are $1,000, your DTI ratio is 50 percent. The VA loan limits are based on the DTI ratio.

When looking at your DTI ratio, you want to ensure it's below 50%. Anything higher than that could be a cause for concern.

How to Calculate DTI for a VA Mortgage

As an example, consider that you pay out $900 per month. Monthly debt payments include the minimum monthly payment:

credit card payment(s),
monthly student loan payment(s) (if applicable),
car payment(s),
court-ordered child support and alimony, and
any other contractual obligation payment.
New mortgage payment with real estate taxes and homeowner's insurance

The DTI calculation also takes into account the new mortgage payment. Utility costs are frequently not included in calculations. Mobile phones and other non-credit product payments are not included in the debt-to-income comparison.

After adding up all monthly debt payments, lenders compare the monthly loan payments to the monthly gross income. Additionally, the lender will include non-taxable income. Disability income, social security, and any other monthly income not taxed by the IRS may all be included in the gross monthly income total.

To demonstrate the debt-to-income debt ratio, we'll use the following example:

Monthly income – $3,000

Automobile payment – $200
Payments made with a credit card – $100
Loan for school – $100
$500 for a new mortgage payment
TOTAL AMOUNT = $900

Now divide $900 into monthly debt payments by the gross monthly income of $3,000.

In this example, the debt-to-income ratio is 30%, which is an excellent debt-to-income ratio. However, consider including a second vehicle payment of $300 and $150 in credit card debt; the mortgage payment is $700.

In that case, your monthly debt ratio explodes to 52% ($1,550 divided by $3,000).
Automobile payment – $200 (1)
Automobile payment – $300 (2)
Pay with a credit card – $150
Loan for school – $200
Payment on a new mortgage – $700
TOTAL – $1,550 DTI – 52%

The VA's optimal debt-to-income ratio is 41%. However, some lenders will approve a loan application with a debt percentage of up to 50%. In comparison, other lenders will even accept a loan with a debt percentage of up to 60%.

What is VA Residual Income?

When determining the debt-to-income ratio, lenders dealing with the VA must consider discretionary income. The money left over after covering all monthly expenses, such as taxes, utilities, credit card bills, and student loans, is discretionary income. The borrower's residual income must be more than the VA's income guidelines for their area.

The cost of upkeep and utility payments are considered when calculating residual income. The VA assists lenders in determining if the borrower(s) have adequate income to pay for essential costs like food and petrol by providing charts that consider the family size and geographic location. Two charts are available: one for loans up to $79,999 and the other for loans beyond $79,999.

Subtract monthly debt payments from gross income to get residual income. For instance, the needed residual income is $1,025 for a four-person family in the Northeast with a $3,000 monthly salary. To satisfy the VA residual requirement, the borrower must pay off some debts or reduce the purchase price if the residual income is less than $1,025.

VA Residual Income Chart

VA Residual Income Calculation

You can download this spreadsheet from the VA.

VA residual income worksheet

What if my residual income or debt-to-income ratio exceeds the limits?

Submitting a loan application is a crucial first step to securing a mortgage. One essential factor to consider is residual income, which determines how much you can afford. If you meet the requirements, you could be eligible for a VA loan, which typically requires a good debt-to-income ratio.

Calculate your back-end DTI using the VA's recommended ratio to ensure VA loan eligibility. This calculation will help determine your loan approval for a VA loan. If you do not qualify for a VA loan, a conventional loan may be an option, depending on the debt-to-income ratio required.

Meeting minimum property requirements is also vital to the VA home loan requirements. The maximum DTI ratio allowed for VA loans is typically higher than for conventional loans. Suppose you have a high DTI; compensating factors such as savings or a credit score of 720 may help you get a VA loan.

Debt-to-income ratio FAQs

Q. How Important is the Debt to Income Ratio?

A. Debt-to-income ratio is one of the lenders' most essential factors when approving a loan. The debt-to-income ratio measures a person's debt compared to their annual income. A high debt-to-income ratio can indicate that a person is struggling to make ends meet and may be unable to afford more debt. Lenders are often less likely to approve a loan for someone with a high debt-to-income ratio.

Q. How to Improve the Debt Ratio?

A. There are a few ways to improve the VA Debt to Income Ratio. One way is to increase income, lowering the Debt to Income Ratio. Another way is to decrease debt, reducing the Debt to Income Ratio. There are also ways to improve the ratio by increasing veterans' housing allowance.

Q. What is a Good Debt to Income Ratio for VA Loan?

A. an excellent debt-to-income ratio for VA loans is 41% or less. Your monthly debts (including the new mortgage) should be 41% of your monthly income. Remember that this is just a general guideline; your lender may have stricter requirements.

Conclusion

VA loans can be a great option when you're looking to buy a home. However, understanding the rules surrounding the debt-to-income ratio is crucial. It's important to remember that lenders will look at more than just this ratio when considering your loan application, including your credit score and ability to repay the loan.

To learn more about VA loan qualifications and determine if you're eligible for this type of home loan, including the service requirements for a VA, residual income requirements, and the gross monthly income that goes towards a loan, consult with a lender. They can help you understand the requirements for VA loans and even offer advice on how to lower your debt-to-income ratio if needed.

You can download this spreadsheet from the VA.

SOURCE:
Chapter 8. Borrower Fees and Charges and the VA
Funding Fee