“How much VA Mortgage can I afford?” is one of the most commonly asked questions a California Veteran has during the process of buying a home, And whether it’s you asking that question of yourself, or a lender calculating it for you, at some point along the way, you’ll need an answer to this question, along with “what is needed to qualify for a VA loan?”. So the sooner you understand how this is calculated, the sooner you’ll discover what price range of home you should be looking at.
Lender Lingo
Before we get too deep into the weeds of mortgage industry lexicon, let’s take a look at some basic terms used in this analysis.
- Qualified Income: This is the amount of income your Loan Officer feels confident will be approved by underwriters. Let’s say you make a base salary of $108,000 per year, but you’re also eligible for Overtime and Bonus Income. Typically you will need to have earned overtime and bonus income for two years before it can be added to your Qualified Income. A two-year average of the Overtime and Bonus Income is used. This is also true of Commission Income. Most importantly, the income used to qualify you will always be your Gross Income; i.e. before taxes. (for self-employed borrower, the income after expenses, net profit)
- Debt to Income Ratio (DTI): What percentage of your Qualified Income is being used to pay all your monthly debt obligations? This is just simple division, where you take the amount you owe monthly and divide that amount by your Qualified Income. Your monthly debt will not include things like taxes, car insurance, groceries, utilities, etc., but will include car payments, minimum credit card payments, student loans, and any other monthly payment that appears on your credit report.
- Maximum DTI: Underwriters cannot let you spend more than the lender guidelines allow for your specific loan product. There needs to be room in your Qualified Income to pay state & Federal taxes, buy groceries, gas for your car, etc. And if after a full review of your financial documentation, your Loan Officer calculates your DTI to be higher than the maximum allowed, then you may want to lower your price point for the new home. The good news for California Veterans is that VA loans have the highest DTI allowance of all mortgage products. Technically VA does not have a maximum DTI. While VA does not institute a maximum DTI, most lenders do. Some lenders will not allow the DTI to be higher than 50%, and some cap it at 55%. But there are lenders that will follow VA and not have a maximum DTI, instead relying on VA’s Residual Income calculation.
- Residual Income: The only loan program that uses the Residual Income calculation is VA. This carries more weight the DTI when it comes to VA loans. Residual Income is essentially what is left of your income after paying your PITI, car payments, student loans and other debt payments, income taxes, and home maintenance. Yes, this calculation takes into account home maintenance and changes based on the size (square footage) of the home you buy. The calculation also takes into account how large your family is. For example, a family of 5 will need to have more Residual Income than a single Veteran.
- Housing Expense: How much money are you obligated to pay each month to sustain the home in question? Lenders call this your PITI(A). It’s the full monthly cost, including Principal & Interest payments on your mortgage, Property Taxes to the County, and the monthly cost of your annual Homeowner’s Insurance policy. Additionally, if your home is located in a community managed by a Homeowner’s Association, your housing expense will need to include your monthly HOA dues. Note that whenever a Lender discusses PITI, it is assumed that it’s “all-in”, including any HOA, 2nd mortgage payments, Lease Payments, etc.
Examples of Debt to Income Calculations
Now that we’ve reviewed some basic definitions, let’s run thru a couple of examples to see how it all comes together
Here’s a fairly typical example of Consumer Debt for an average household:
- Car Payment #1 $300
- Car Payment #2 $450
- Visa Card $25
- MasterCard $150
- Student Loans $250
- Total of Consumer Monthly Debt Obligations $1,175
Now let’s look at a hypothetical breakdown of PITI for the house you’re looking to buy. We’ll assume the property is in Orange County where the High Balance Conforming Loan Limit is the highest in the state, according to the FHFA. If we use 100% VA financing, we’ll have a loan amount of $679,650 (2018 Orange County loan limit for 100% financing). *Note: Because your PITI will require knowledge of current interest rates and the subsequent Principal & Interest payment, as well as qualifying estimates for Taxes & Insurance, you will need to speak with an experienced Mortgage Loan Originator – VA Specialist to get an accurate estimate for PITI.
- Principal & Interest on new mortgage (P&I) $3,244 (using 4.25% note rate, 4.37 APR on Jan 7, 2018, assuming no VA Funding Fee)
- Property Taxes (T) $707 (1.25% of purchase price / 12)
- Homeowner’s Insurance (I) $141 (.25% of Loan Amount / 12)
- HOA Dues (A) $0
- Combined total of PITI $4,092
- The total amount used for DTI calculation ($1,175 + $4,092) $5,267
Now that we have an accurate number for the total amount of debt required to be serviced each month, we can look at the Qualified Income and come up with a DTI. If we find after a full review of your complete income documentation that you have Qualified Income of $9,000 per month, then we can derive your DTI immediately by the following calculation:
$5,267 ÷ $9,000 = .626 (58.52% DTI)
This DTI is too high for either FHA or Conventional mortgages, but could still work with VA Financing depending on the Residual Income and other compensating factors. However, since many lenders max the DTI for 100 % VA Financing at 55%, and because we want to make sure you have money left over to go out to dinner or maybe even take a vacation, we should work our initial plans to be at or below 55%. (Even 55% is very high. But for someone who has income that is not being used in the debt to income calculation, pushing the DTI to 55% may not be a big deal.).
In an analysis like this, we know that certain things cannot change. For example, we cannot increase your income without clear, complete and acceptable documentation to support it. And on the other side, you have the monthly consumer debt. We’ll assume that none of those debts can be paid off and therefore must remain in your DTI calculation. It follows then, that if: a) your income and debt cannot change; b) the DTI maximum is fixed, and c) your DTI is too high, then the only other variable that can change is the PITI on the new home. Therefore, we simply take 55% of your Qualified Income ($9,000 x 55% = $4,950) and subtract out the Consumer Debt of $1,175. This leaves us with an all-in PITI that cannot exceed $3,775 since doing so would put your DTI over the declared maximum.
The rest of it is up to your Loan Officer. Again, calculating the monthly PITI will require guidance on current rates for your specific transaction. But let’s lower the hypothetical purchase price to $600,000 and see if it works using the same assumptions as before.
- Principal & Interest on new mortgage (P&I) $2,952 (using 4.25% note rate, 4.37 APR on Jan 7, 2018, assuming no VA Funding Fee)
- Property Taxes (T) $625
- Homeowner’s Insurance (I) $125
- HOA Dues (A) $0
- Combined total of PITI $3,702
- The combined total for both consumer debt and the proposed PITI $4,877
Using the same formula as before, the DTI calculation would look as follows:
4,877 ÷ 9,000 = .5234 (54.18% DTI)
In our examples above, we started with a hypothetical purchase price of $679,650 but quickly discovered the DTI of 58.52% was higher than many lenders will allow. In our second example, we found that a purchase price of $600,000 provided us a DTI of 54.18%, which may be more feasible for our test borrower. We can, therefore, conclude that the approximate maximum amount of mortgage that you can afford is very near the $600,000 level. To go out shopping for homes much higher than that would potentially put you in a situation where you couldn;t afford to do anything beyond making your house payment.
One final thing to remember about maximum DTI: Every loan product, mortgage type and indeed, every individual loan application, will each have their own limits. We’ve used a maximum 55% in our VA examples above, but the VA is in the habit of helping Veterans get into homes, and it’s not at all uncommon to see an underwriter make an exception if there are what we call “Compensating Factors” on your application. Things considered as compensating factors include excellent credit, large amounts of assets in savings and retirement plans, several years in the same job, etc. Conventional loan guidelines are less forgiving, and you will find that the 50% maximum DTI on most Conventional loans is fixed without exception. Always work with an experienced Mortgage Loan Originator to find out what will apply in your situation.
Authored by Tim Storm, a California VA Loan Officer specializing in VA Loans. MLO 223456. – Please contact my office at the Home Point Financial. My direct line is 949-640-3102. I will prepare custom VA loan scenarios which will be matched up to your financial goals, both long and short-term. I also prepare a Video Explanation of your scenarios so that you are able to fully understand the numbers BEFORE you have started the loan process.