When you apply for a VA guaranteed mortgage loan, the lender will review various aspects of your financial situation to determine if you’re qualified. One of the things they examine is the current amount of debt that you have, including the new debt that would come with the mortgage loan.
And this leads to a common question among borrowers: How much debt can I have and still qualify for a VA loan?
The short answer is that it’s up to the mortgage lender. While the Department of Veterans Affairs prefers to see a debt to income ratio no higher than 41%, they give mortgage lenders leeway to approve borrowers with higher debt ratios.
What Is a Debt-to-Income Ratio (DTI)?
To properly address this question, we have to start by defining the net to income ratio. Along with your credit score and income, this is one of the most important factors when it comes to qualifying for a VA loan. debt ratios apply to other types of mortgage loans as well, including FHA and conventional. But here, we will limit our discussion to the VA loan program in particular.
Your debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes towards paying your monthly debt obligations. DTI is calculated by dividing your total monthly debt payments by your gross monthly income and multiplying by 100.
Lenders and the VA use DTI to assess your ability to afford a mortgage payment. A lower DTI ratio indicates that you have more disposable income to cover your monthly mortgage payment and other expenses.
You actually have two of these ratios, from the lender’s perspective:
Front-end DTI ratio (a.k.a., “housing ratio”): The percentage of a borrower’s gross monthly income that goes towards housing-related expenses, including mortgage payments, property taxes, and homeowners insurance.
Back-end DTI ratio: The percentage of a borrower’s gross monthly income that goes towards all monthly debt obligations, including housing-related expenses, credit card payments, student loan payments, and auto loan payments.
How to Calculate the DTI Ratio
Here’s an example calculation for a borrower’s back-end debt ratio:
Monthly income: $5,000
Monthly mortgage payment: $1,000
Other monthly debt payments: $500 (credit cards, student loans, etc.)
Total monthly debt payments: $1,000 + $500 = $1,500
Debt-to-income ratio: $1,500 / $5,000 * 100 = 30%
This means that 30% of the borrower’s gross monthly income goes towards paying their monthly debt obligations.
This math is important because it helps us answer the question we started with. How much debt can I have and still qualify for a VA guaranteed mortgage loan
The VA’s 41% Rule And Why It’s Not a Dealbreaker
The VA doesn’t set an official limit for debt levels. But they do require lenders to give applicants some additional scrutiny when their DTI ratio is greater than 41%. Specifically, they encourage mortgage lenders to seek compensating factors that might offset the risk associated with higher debt levels.
For example, an article on the VA.gov website:
“The debt-to-income ratio determines if you can qualify for VA loans. The acceptable debt-to-income ratio for a VA loan is 41%.”
But that same article goes on to state:
“The mortgage underwriters will make a thorough inspection of your loan application if your debt-to-income ratio is more than 41%. However, it does not mean that your VA loan application will be rejected straightway.”
In some cases, borrowers with debt ratios well above 50% can still qualify for a VA loan. In those cases, the mortgage underwriter will take a closer look at the borrower’s qualifications, as mentioned in the above quote.
What is the underwriter looking for? In short, compensating factors.
In the context of VA mortgage underwriting, a compensating factor is any condition that offsets the higher risk that comes with a larger debt load. According to VA loan guidelines, when a person’s back-end debt ratio exceeds 41%, the underwriter should “dig deeper” and try to identify compensating factors.
A List of Compensating Factors for VA Loans
According to the official VA loan handbook, compensating factors “are especially important when reviewing loans which are marginal with respect to residual income or debt-to-income ratio.”
So, a person with a DTI ratio above the 41% threshold mentioned earlier could still qualify for a VA loan, if the underwriter can document one or more compensating factors. For example, if a borrower has excellent credit and significant liquid assets, they might be able to get a VA loan even with an above-average debt ratio.
Compensating factors for VA loans include, but are not limited to, the following:
- excellent credit history
- conservative use of consumer credit
- minimal consumer debt
- long-term employment
- significant liquid assets
- sizable down payment
- little or no increase in housing expense
- satisfactory homeownership experience
- high residual income
Note: in this context, “residual income” refers to money that the borrower has left over each month after paying all debt obligations. For example, if you can pay all of your recurring monthly debts and still have some extra cash each month, you have what’s known as residual income.
This is one of several compensating factors that could help you qualify for a VA loan even if you have a debt ratio above the threshold mentioned earlier.
Putting some money down could also help you qualify for a VA loan with high DTI ratio. You’re not required to make a down payment when using a VA loan. In fact, that’s one of the features that attracts borrowers to this program in the first place. It allows for 100% financing.
But there are scenarios where a borrower can improve their chance for approval by making a down payment of some kind, and that includes having a high debt load.