The debt to income ratio is a very important calculation when it comes to qualifying for an Orange County VA home loan. Sometimes just referred to as the “Debt Ratios”, or DTIR (debt to income ratio), it calculates the Veterans ratio of monthly payments to their gross monthly income. Knowing how this ratio is calculated is important in determining a price range for a home, even though VA does not actually have a “maximum” debt to income ratio.
Components of the Debt to Income Ratio
The first figures used in determining the DTIR are the monthly debts for the Veteran. The debts include the following.
- Car payments – If there are more than 10 payment remaining
- Minimum credit card payments
- Installment loan payments (more than 10 payments remaining)
- Student loan payments. If these are deferred for more than one year from the close of escrow then the payment can be excluded from the calculation.
- Deductions / allotments on the pay stubs or LES may also be included in the debt ratios depending on what they are for. (401K payments are not included in the DTIR on VA loans)
- Rental negative if a rental property is owned and the collected rent will not cover the full mortgage payment, including property taxes, insurance and home owners association dues.
- Co- signed debts. In some cases these can be removed from the ratio if it can be proven that the primary debtor has been making 100% of the payment for the past 12 months.
- Child care expense – this is specific to VA loans only. If Child Care expenses are being written off on the tax returns then they will need to be included the the DTIR, unless it can be proven that the child car expense no longer exists.
- Alimony or child support payments
- Debts from a non-purchasing spouse. This is important and is specific to Community Property states like California. Even if a spouse will not be on the loan, if they have debt payments that do not appear on the primary Veteran borrowers credit report, then those debts must be included in the DTIR.
And of course, the proposed mortgage payment, which includes the principal, interest, property taxes, insurance, and home owners association dues (if applicable).
The Income Portion of the DTIR
You would think income would be a fairly straight forward calculation. But not always. For a Veteran who is a “W2” employee and has taxes taken from their paycheck, it is an easy calculation. The VA lender will use the gross income before taxes. For those who earn commission, the commission portion of the income will be averaged for the previous two years. And for those who are self employed, income is also averaged over a two year time period. The income should be “on going”. Active duty military will also have BAS and BAH income, which can be “grossed up” by multiplying the non-taxed income by 1.25. For example, BAH and BAS of $1,800 x 1.25 = $2,250, which would be the income used for calculating the DTIR.
How High Can the DTIR Be?
The guideline for the DTIR on a VA loan is 41%, meaning that 41% of the Veterans gross income can go towards all debt payments. But that is just the guideline. In most cases the lender will use an Automated Underwriting System (AUS) like Fannie Mae’s Desktop Underwriter or Freddie Mac’s Loan Prospector. With an AUS approval, there is no limit to the debt to income ratios. Approval with a DTIR above 60% are possible. However, for VA loans a more important calculation is for Residual Income, which a whole different qualifying calculation that looks at income remaining after all payments are made, including income taxes.
Example of a DTIR Calculation
Let’s assume that our Veteran, Owen Cowan, or “OC” for short, has gross monthly income of $8,000 per month. 41% of $8,000 is $3,280. OC also has a car payment of $300 per month, but no other debt. Knowing that as a “guideline” OC can have $3,280 in total debt payments, and knowing that he has a $300 car payment, we are able to conclude that the total mortgage payment, including taxes and insurance, can be $2,980. Assuming a purchase price of $470,000 with $0 down at an interest rate of 4.25% results in a principal and interest payment of $2,362. (Including the VA Funding Fee for a first time VA loan user, the total loan amount would be $480,105). Property taxes are typically estimated by multiplying the purchase price by 1.25% and dividing by 12. In this case, that comes to $498 per month. The home owners insurance estimate is quite often estimated by multiplying .3% times the loan amount and dividing by 12, which in this case comes to $118 per month. That comes to a total PITI (Principal, interest, taxes, and insurance) of $2,969. $2,969 plus the $300 car payment divided by $8,000 gross income comes to a DTIR of 41%.
For a Veteran who is trying to figure out what they qualify for this calculation is very important. But it is also important to figure out your own budget. For some, pushing the ratios to 50% (payment over $3,600) may be easily possible, which would put the price closer to $580,000. For an Orange County Veteran wanting to keep their payment no higher than $2,500, a price closer to $400,000 would be needed.
The Most Accurate Way to Determine the Debt to Income Ratio
The most accurate way to determine your Debt to Income Ratio is to contact an Orange County VA loan specialist. A good VA loan officer will be able to provide custom VA loan scenarios with a complete breakdown of the purchase price, loan amount, payment, and amount of money needed to close using VA financing. And the scenarios should include a thorough explanation of the numbers on the scenarios. Many times a video presentation can be prepared that can be referred back to and shared if needed. The video presentation is especially helpful for those who don’t have time for a face to face meeting.
Authored by Tim Storm, a California Mortgage Loan Officer MLO 223456 – Please contact my office at the Emery Financial. Direct line at 949-640-3102. www.OrangeCountyVALoans.comGoogle+