VA lenders use debt ratios to help determine affordability. Yet VA lenders are not unique in this regard, all lenders employ a similar method when calculating current debt with gross monthly income. The VA uses a debt ratio of .41 when approving a VA home loan application. That simply means if someone makes $6,000 per month, before withholdings, VA loans require mortgage payments plus other revolving and installment debt payments be no greater than $6,000 X .41 = $2,460.
But VA lenders go a bit beyond that debt ratio and consider the difference, if any, between what the veteran is paying for housing now and what the new payment will be. If the disparity is too great, the VA loan will require a bit more scrutiny. This disparity is called payment shock.
Payment shock is expressed as a percentage and is a number that represents the increase in housing expense from the current rental or mortgage payment and is typically limited to 120 percent of the previous housing payment and can apply to borrowers who have credit scores between 620 and 640. Note here that any VA lender can have their own internal requirement but this shock guideline is a common one.
For example, say a borrower has a credit score of 635 and the current rental payment is $1,500. A VA lender with a payment shock requirement can limit the new monthly payment to 120 percent of $1,500, or $1,800, regardless of any qualifying debt ratio.
The reasoning is when someone has been paying a specific amount each month for housing then suddenly experiences a significant increase with a mortgage payment, will the borrowers still be able to make the higher payment each month?
Borrowers with excellent credit scores, leftover cash in the bank, strong employment history and other compensating factors may have the payment shock requirement waived, but this can vary based upon the lender. If your new payment will be much higher than what you’re currently paying, be prepared to explain to the lender why you will be able to handle the higher payments.