VA lending guidelines include, among other things, requiring the lender to determine the veteran is able to afford the new monthly payments associated with the loan. The VA issues a standard that lenders use when making this determination and it involves calculating debt-to-income ratios. This ratio is a number that represents total monthly obligations as it relates to gross monthly income and that number is 41.
Calculating the Payments
A VA Lender takes the loan amount, extends it over a particular term, say 30 years, and then applies the current interest rate for that loan. For a 30 year loan on $250,000 loan at 4.50 percent, the principal and interest payment is $1,266 per month. Yet lenders don't stop there.
Lenders also count 1/12th of the annual property tax bill and 1/12th of the annual insurance premium. If there are any other monthly housing fees such as homeowners association charges, those fees are included as well.
Say that the annual property tax bill in this example is $2,500 or $208 per month and the yearly insurance premium is $1,250 or $104 per month. The lender then adds all payments together to arrive at the total housing payment:
$1,266 208 104 $1,578
Now the lender considers all other monthly credit obligations such as a credit card payment, automobile loan or installment loan. If there is one car payment of $400 and one minimum credit card payment of $50, the total monthly payment is
$1,578 400 50 $2,028
Other monthly expenses such as food, utilities or entertainment aren't included.
If the borrower's gross monthly income is $5,000, then the ratio in this example is $2,028 divided by $5,000 = .41, or the maximum VA debt ratio limit. Anything at or below that 41 number is an allowable amount of debt according to the VA.
Calculating the Income
We used $5,000 in this example but where does that figure come from? The most common form of income comes from wages, or W2 income. And remember, it's the gross amount, not the figure after deductions are taken out.
For the self-employed borrower, the lender will average the two most recent year's income as reported on the tax returns as long as the income is considered both consistent and likely to continue.
But what if that's not enough to qualify? Are there other types of income that can be used? Yes, there is. It's called, appropriately, "other" income and there's even a blank field for it, alongside additional acceptable income such as bonuses, commissions, overtime, rental and dividends and interest. And just like self-employment income, as long as the VA lender can document a history and determine the income is likely to continue, the additional income may be used.
Overtime. Overtime income can be used by those who are paid hourly if it can be shown there is a two year history of overtime pay and consistent with year to date overtime.
Bonuses. Bonus income may also be used if the bonus income is issued on a regular basis and is consistent. A Christmas bonus paid two years ago but not last year won't be counted, because there's no two year history nor consistency and the lender can't make a determination that the income will continue.
Commissions. Commission income is allowed in the same manner that bonuses are counted. Consistency, history and a continuance.
Dividends/Interest. A two year history is established by reviewing tax returns and investment statements.
Net Rental Income. If the veteran has rental income from an existing property, the net amount reported on Schedule E of the federal income tax return may be counted toward final income.
Other. Additional income types that can be counted as long as a history and consistency is established. Alimony and support payments may be used and documented with a copy of the signed divorce decreed. Annuity income can be counted under the same guidelines as well as income from retirement, social security or disability income.
The final note here is that if you feel as though you're going to really "stretch" it every month when making your payments, it's advised not to take the loan, regardless of any debt ratio number. If you feel uncomfortable with a potential debt load, reconsider your options. Put more money down or lower your loan amount if you feel this way. But if you have more than just wage income, it might help you qualify for the home you really want.