There are many factors that come into play when you are applying for any type of loan, but the VA loan puts a majority of its focus on your residual income. In fact, this number could mean more to the VA than your debt-to-income ratio, which is typically a very important factor in the mortgage approval process. In fact, the VA attributes their low foreclosure rate to the fact that they pay so much attention to the amount of residual income a borrower has at the time of application.
Difference Between Debt Ratio and Residual Income
Many people are unaware of what residual income is and how it affects their VA loan; they also consider it to be the same as the debt ratio, but they are two different numbers.
- The debt ratio is the amount of your income that goes towards paying your monthly obligations. This includes your mortgage, taxes, interest, insurance, and any other monthly obligations (credit cards, car payments, and student loans). The total of your monthly debts is divided by your gross monthly income to come up with your debt ratio. The VA will look at your front-end ratio (mortgage, interest, taxes, and insurance) and your back-end ratio (mortgage payment plus other monthly obligations). In general, the VA the maximum debt ratio allowed for a VA loan is 41% on the back-end, but there are exceptions to that rule.
- The residual income is the amount of money you have left on a monthly basis after paying your monthly obligations. These obligations include everything discussed above. The basic way to figure it out is to consider any debt that reports on your credit report – take the amount reporting (the minimum payment for credit cards) and subtract it from your gross monthly income to come up with your residual income, or the amount of money you have left after you pay your bills.
Why the VA Cares About Residual Income
Why does the VA care how much money you have left after your debts are paid? Isn’t the debt ratio enough to figure out eligibility for a loan? The answer is a clear cut – no. The VA cares about the money you have left over because they want to make sure that your everyday living expenses are paid. They want to know that no borrower is sacrificing clothing, groceries, or any other essential living expenses just to make their mortgage payment. This is why their foreclosure rate is so low – they care that every borrower is properly cared for and will not be forced to make the decision between clothing and keeping their home. This is when default begins to occur when borrowers are forced to make a decision, some of which end up defaulting on their loan.
What are the Residual Income Requirements?
There is not one standard requirement for every VA loan – it depends on the area of the country that you live in as well as the size of your family to determine your residual income requirement. The requirements vary dramatically. For example:
A family of 4 can differ like this:
- Northeast Region : $1,025
- Midwest Region: $1,003
- South Region: $1,003
- West Region: $1,017
The amount of residual income goes up or down accordingly for each family member that you add or subtract from the average family size of 4 members. If you have more than 5 members, for example in the South Region, you would add $80 for each member over 5 members to the $1,039 required amount.
When does Residual Income Help?
An applicant with a high debt ratio, which means that it exceeds 41%, can provide a compensating factor by having excessive residual income. Generally, the VA considers residual income over 20% higher than the required amount for their area excessive. At that point, the debt ratio would not play a role in the approval of the loan. For example, a borrower in the Northeast Region with a family of 4 would need to have a residual income of $1,230 in order for their debt ratio to not be a factor in the process.
Why you should Focus on Residual Income
Whether you are applying for a VA loan or any other type of loan, you should be focusing on your residual income too. It is a way to measure how well you will be able to balance the other expenses in your life. If your mortgage or any other monthly obligations take up too much of your monthly income, it can become a struggle to purchase groceries, clothing, and provide entertainment. Over time, that stress can cause you to default on your mortgage and put you at risk for losing your home – calculating that income can be a great help to prevent that from happening – VA loan or not!
