There’s one unique factor about VA loans. They require a specific amount of residual income. Knowing how to calculate this figure can help you prepare for a VA loan. The VA cares about the income left after you pay your bills more than many other factors. It shows that you don’t have to sacrifice daily living expenses to pay your mortgage. This helps lower your risk of default. In fact, the VA has one of the lowest default rates among all other mortgage programs.
Figuring Out Your Residual Income
Figuring out your residual income is a multiple step process. First, you must determine your gross monthly income.
Here are a few examples:
- If you get paid an annual salary, take your annual salary and divide it by 12. This is your gross monthly income.
- If you get paid hourly and work full time, take your hourly rate x 40. Then multiply that number by 52. This is your annual salary. Now divide that number by 12 to get your gross monthly income.
- Any other income can be annualized as well. Take the total over a period of 12 or 24 months. Then divide it by the proper number (12 for 1 year and 24 for 2 years). This gives you your gross monthly income.
Once you have your monthly income amount, you must figure out your total monthly debts. This includes your proposed mortgage payment and current monthly debts. The VA only concerns themselves with major monthly expenses. Things like installment loans, revolving debt, and child support are the big ones. They’ll also estimate your utility cost based on where you live. You’ll need to total your monthly debts as follows:
- Installment loan payments including student and auto loans
- Credit card minimum payments
- Child support or alimony payments
- Proposed total monthly housing payment (including taxes, insurance, and association dues)
Once you total your monthly obligations, you can take the final step – figuring out your residual income.
Take your gross monthly income and subtract your total monthly debts from above. This is your residual income or money you have left over at the end of the month.
Figuring Out Your Debt Ratio
Your debt ratio is a different calculation. It’s how your income compares to your monthly debts. Lenders divide your liabilities by your monthly income to get the ratio. You can use the same numbers from above, without the utilities, though. Lenders don’t figure utility costs into debt ratios. They will, however, figure alimony or child support in it if you are legally obligated to pay it.
For example, let’s say your monthly gross income equals $4,000. Your monthly debts total $1,500. Your calculation would be as follows:
$1500/$4000 = 37.5%
This means you have a debt ratio of 37.5%. The VA asks that borrowers have a maximum debt ratio of 41%, so you would fall in line with the guidelines.
The VA doesn’t put a lot of emphasis on the debt ratio. In fact, they are the only loan program that looks at the back-end ratio and not the housing ratio. They prefer a maximum 41% ratio, but if you have a higher ratio, you can make up for it. You must have residual income that exceeds 20% of the required amount for your area. For example, if you need $1,062 to qualify for the VA loan, you would need $1,274 with a higher DTI.
Will Lower Residual Income Disqualify You?
The good news is lenders don’t look at just your residual income. It does play a role, but it’s not the only factor. This may vary by lender, though. Some require the VA minimum disposable income, while others look at the big picture. If you have other compensating factors, you may qualify for the loan. Compensating factors are things that make up for the lower monthly income. Let’s say you have a low debt ratio or high credit score. These factors could make up for the higher risk. Maybe instead of taking advantage of the no down payment, you put money down. This is another way to make up for the risk.
A rule of thumb is if one lender turns you down, check with another. However, if you are nowhere near the residual income amount, you may not find a lender. It depends on the situation. The more positive factors you can provide, the better off your chances of approval.
The debt ratio and disposable income are the main components of a VA approval. They have loose guidelines regarding a credit score – 620 is usually the minimum allowed. They also require a decent credit history. No collections in the last 12 months or no bankruptcies or foreclosures during the last 2 years are the minimum requirements.
The VA loan is very flexible, though. The VA sets the minimum guidelines, which are not very strict. It’s up to each lender to decide what they require then. Some lenders have a higher threshold for risk. Others prefer only perfect loan applications. The lenders that allow the riskier loans are able to do so because of the VA’s guarantee to back up the loan.
Keep in mind, if you take a VA loan, you’ll pay an upfront funding fee. It equals 2.15% of the loan amount. It can be quite a bit of money, but it helps fund the VA. In many cases, you can wrap the cost into your loan. Of course, this means you’ll pay interest on the fee, which increases how much you pay. Carefully determine which option makes the most sense. If you know you’ll stay in the home for a long time, paying the fee upfront might make sense. This limits the amount of interest you pay. If, however, you know it’s a short-term purchase, you may wrap it in and pay minimal interest.
Residual income is a major component of the VA loan, though. Make sure you accurately calculate your income before applying for a loan. If you are on the low side, consider cutting your costs and paying down debt. This will help increase your disposable income and your chances for a VA approval.