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RefinanceWhat is VA residual income and how does it affect your VA loan?
In addition to traditional debt-to-income ratios, VA loans consider the loan applicant’s net income after certain expenses are deducted.
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When most people think of qualifying for a mortgage loan and whether or not they can afford the monthly payment, they consider the debt they already have and the size of the mortgage payment they are about to take on. Common sense would lead us to subtracting the debts and new house payment from our net income - how much we take home after taxes and deductions - to see how much we'd have left.
With the exception of VA loans, which is why you're reading this, mortgage loans do not work this way. When you apply for a mortgage, your lender will use a percentage to determine the size of the loan for which you'll qualify, not how much actual money you have left after you pay your bills.
VA loans work a little differently. Yes, they consider that same percentage that lenders calculate for other types of mortgage, but VA loans use residual income to determine if you'll have enough money left over after you pay essential bills like debt and childcare.
If you're applying for a VA loan and you know things will be tight if you take on a new house payment, understanding your residual income may save you time and improve your chances of not taking on more than you can handle.
What is a debt-to-income ratio?
Your debt-to-income ratio is commonly referred to as your DTI, and it's the percentage mentioned above. If your DTI is within an acceptable range, you’ve successfully checked one of the many boxes needed to obtain a VA loan.
DTI is your monthly debt payments, including your new house payment of principal, interest, taxes, and homeowners insurance, and homeowner association (HOA) dues divided by your GROSS monthly income. Debt is typically defined as money you have borrowed and on which you are making monthly payments over time. Credit card payments, autos and other motor vehicles, student loans, mortgages, including property taxes and homeowners insurance, and personal loans are the most common examples and are all included in your DTI.
While there isn’t necessarily a set-in-stone DTI standard, maintaining a debt-to-income ratio at or below 40% is often advised. The lower your DTI the better. However, when qualifying for a VA loan, a low, traditionally calculated DTI may not be enough.
What is residual income?
VA underwriters use loan analysis form 26-6393 to compute your residual income. Residual income is what remains after additional expenses that are not part of your tradtional DTI are considered. Residual income is a better metric for determining whether or not you can afford a mortgage payment because it addresses real dollars and not a sometimes misleading percentage.
Before we tackle what goes into figuring our residual income, here are two quick, very basic, and over-simplified examples of why residual income is important.
Consider two families of four in the Midwest:
| Family 1 | Family 2 | |
|---|---|---|
| Gross Monthly Income | $4,000 | $15,000 |
| VA Loan Payment | $1,000 | $4,000 |
| Other Debt Payments | $200 | $3,500 |
| Traditional DTI | 30% | 50% |
From a DTI standpoint, Family 1 looks to be in a much better place than family 2. Now, let's consider residual income, which includes expenses like child care.
| Family 1 | Family 2 | |
|---|---|---|
| Gross Monthly Income | $4,000 | $15,000 |
| VA Loan Payment | $1,000 | $4,000 |
| Other Debt Payments | $200 | $3,500 |
| Child Care | $1,200 | $1,200 |
| VA Loan DTI | 60% | 58% |
| Taxes | $600 | $3,000 |
| Residual Income | $1,000 | $3,300 |
Notice how both DTIs computed from a VA standpoint are similar. However, Family 2 has $3,300 remaining for family support versus only $1,000 for Family 1.
VA has established minimum requirements for residual income in order to qualify for a VA loan. Using the following tables, the required residual income for a family of four in the Midwest is $1,003 when purchasing a home valued greater than $80,000. Additionally, when the computed DTI is greater than 41%, VA requires the residual income requirement to be increased by 20%. In our case, the $1,003 minimum would increase to $1,204.
Family 1 has a DTI of 60% and falls short of the family support requirement by $204. However, Family 2 exceeds the support requirement by over $2,000 despite a DTI of nearly 60%. Family 2 may have their loan approved assuming they meet all other VA loan requirements and have a strong credit profile. Family 2 will not qualify for this VA loan.
| Table of Residual Incomes by Region for Loan Amounts of $79,999 and Below | ||||
|---|---|---|---|---|
| Family Size | Northeast | Midwest | South | West |
| 1 | $390 | $382 | $382 | $425 |
| 2 | $654 | $641 | $641 | $713 |
| 3 | $788 | $772 | $772 | $859 |
| 4 | $888 | $868 | $868 | $967 |
| 5 | $921 | $902 | $902 | $1,004 |
| Add $75 for each additional member up to a family of seven. | ||||
| Table of Residual Incomes by Region for Loan Amounts of $80,000 and Above | ||||
|---|---|---|---|---|
| Family Size | Northeast | Midwest | South | West |
| 1 | $450 | $441 | $441 | $491 |
| 2 | $755 | $738 | $738 | $823 |
| 3 | $909 | $889 | $889 | $990 |
| 4 | $1,025 | $1,003 | $1,003 | $1,117 |
| 5 | $1,062 | $1,039 | $1,039 | $1,158 |
| Add $80 for each additional member up to a family of seven. | ||||
| Key to Geographic Regions Used in the Preceding Tables | |
|---|---|
| Northeast | Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont |
| Midwest | Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Wisconsin |
| South | Alabama, Arkansas, Delaware, District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, Oklahoma, Puerto Rico, South Carolina, Tennessee, Texas, Virginia, West Virginia |
| West | Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, Oregon, Utah, Washington, Wyoming |
Source: VA Lenders Handbook
The examples above illustrate how debt-to-income ratios can be misleading. Not all high DTIs are the same. Particularily, if your income is higher, your residual income may outweigh a DTI that would be considered too high for conventional mortgage standards.