One of the many advantages of VA loans over traditional mortgages is that the qualification process is easier. Historically, the VA loan program has had one of the lowest delinquency rates compared to other loans. This is due to its commitment to time-tested lending guidelines. One guideline is the debt-to-income ratio or debt ratio.
What is the Debt Ratio?
The debt-to-income ratio is a percentage of the borrower’s overall monthly debt obligations divided by the household’s gross income.
As an example, if your monthly income is $8,000 and you have debt obligations like credit card payments, a car loan, a student loan payment, and your new housing payment that total $3,000, your debt ratio is 37.5% ($3,000 divided by $8,000).
Here’s another way to look at the debt ratio:
- Your annual income is $48,000.
- Your monthly income is $4,000 ($48,000 divided by 12).
- The maximum debt obligation you can have to qualify is $1,640 ($4,000 multiplied by 0.41).
VA Loan Debt Ratio Guidelines
The VA has set a maximum debt ratio of 41%. This means your debt-to-income ratio must be 41% or lower to qualify for a mortgage. Under the VA’s rules, your new housing payment will consist of the following: interest and principal payment, one month’s property taxes, and one month’s homeowners’ insurance plus any HOA or condo fees.
The VA has guidelines on which types of debt must be included in this calculation. Monthly obligations that are included to qualify you include:
Credit card payments (minimum due)
- Installment loans and leases (e.g., car loans)
- Student loans
- Child support
- Children’s day care
Monthly responsibilities that do not count in the debt-to-income ratio include utilities, cell phone, food, electricity and more.
What if Your Debt Ratio is Higher Than 41%?
VA lenders can make allowances to make a loan with a debt ratio higher than 41%. But other considerations must be made in terms of residual income, employment, and credit rating. In this case, the underwriter will do a careful inspection of your application.
You can still qualify if your residual income is at least 20% higher. Also, if your debt-to-income ratio is higher than allowed due to tax-free income.
The most common scenario with a high debt ratio is a higher residual income requirement. Residual income is the amount of money you have remaining each month after paying major expenses. When a borrower’s debt ratio exceeds 41%, the residual income requirement is raised by 20%.
Reducing Your Debt Ratio
If your debt ratio is right at 41%, you can reduce your ratio by paying down debt, lowering your house payment, or borrowing less. Increasing your income can also reduce your debt ratio. However, it’s difficult to earn extra income that will be counted by your lender. To reduce your debt, try these techniques:
Pay more than your minimum monthly payments to pay down debt faster.
- Shop around for better rates on car insurance, internet, and cell phone service. This allows for more money to pay down your debt.
- Eliminate unnecessary expenses such as subscriptions you do not use.