Tackling Debt-to-Income Ratio

Debt-to-Income Ratio Explained

Understand Debt-to-Income Ratio and Residual IncomeDebts pile up sometimes. Car debt, student loans, credit cards, house payments . . . Obviously, no one wants to be in debt. Not really. Unfortunately, it’s a part of life and without a little debt, many opportunities would be unavailable to us. A safeguard has been put in place to help ensure that a person doesn’t take out more debt than they are able. This protects both the lender and the borrower because if the borrower went into a loan unable to pay it back due to too much debt, then both would lose a lot of money and credibility. When it comes to home buying, a borrower is limited by how much they can take out specifically for a home loan. This limit is calculated by the debt-to-income ratio. Find out how debt-to-income ratio affects you.

This ratio usually includes two parts: the back-end ratio and the front-end ratio. The first tells you how much debt you can take out on a house. The second tells you how much debt you can have in total. The ratio changes for different lenders and types of loans, but many require that the ratio be lower than 43 percent, which is actually quite large.

For the VA, the ratio is a little different at 41 percent. So when all of your debt is calculated, it cannot be more than 41 percent of your income every month.

There are some cases where the DTI can exceed the limits and with the VA, this is not unusual, especially since the residual income requirements can trump the debt-to-income ratio.

Residual Income

Simply put, residual income is the money left over after all the personal debt bills have been paid each month. This sounds a lot like the DTI, but the requirements are much different and so can have a big impact on whether a loan is approved or not. The requirements vary by area of the U.S. and household size. For this, the U.S. is split into four regions: West, Northeast, Midwest, and South. If the amount of income left is more than the number designated for your family size and the state you live in, for example, you may better qualify for a VA loan even if you have a lot of debt.

Lower Your DTI and Calculate Residual IncomeThe DTI is more of a guideline compared to the residual income requirements. Think of it this way, having very few debts to pay would make the debt-to-income ratio quite small, but your income could still be far lower than the requirements. If this was the case, the VA loan would probably be denied. But the residual income requirements can also work in your favor if the scenario was just the opposite. With a high DTI over the usual limit and a residual income well above the requirement, you can still get a loan even though most other lenders would deny you.

Save It Up and Pay It Off!

One of the best ways to prepare to take on debt is to work on covering other financial obligations. Having a lower debt-to-income ratio will not only help you get approval, it will also make monthly payments much more manageable so that you can spend more on the enjoyable things in life. Create your own plan to lower your debt-to-income ratio and take control of your finances.

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