The VA offers relaxed underwriting guidelines. They don’t focus on a specific credit score or even a maximum debt ratio. What they do focus on, however, is the amount of residual income you have each month. They are the only loan program that puts such emphasis on this factor.
Keep reading to learn why you should care about your residual income if you are eligible for a VA loan.
What is Residual Income?
Residual income is the money you have left after paying your bills each month. This includes all housing expenses (principal, interest, taxes, and insurance) as well as any other major debts that report on your credit report. Think of bills like your minimum credit card payments, car payments, student loans, or personal loans.
Any money you have left after you cover your major monthly debts is the residual income. You have this money free to cover ‘other’ monthly expenses, such as groceries, clothing, and grooming expenses. This is the money that you need to cover the daily cost of living.
Why Does the VA Care About Residual Income
The VA actually has a minimum amount of residual income you must have in order to qualify for a VA loan. They require these minimums based on your family size and where you live. The larger your family size, the more money you need to cover the daily cost of living for each of them. Likewise, the more expensive the area that you live, the more money you need to cover the daily cost of living.
The VA focuses on these numbers because they feel that borrowers that have enough money to cover their daily cost of living are less likely to default on their mortgage. The VA claims that their low mortgage default rate is because of their focus on the residual income.
What About the Debt Ratio?
You are probably wondering about the debt ratio, after all, that’s the main focus of most other loan programs. While the VA doesn’t put a lot of emphasis on the debt ratio, they do look at it, just in a more casual manner.
In fact, the VA combines the amount of your residual income with your debt ratio to look at the big picture. For example, if you have a high debt ratio, the VA may require that you have more residual income than is actually required for your area and family size. The extra residual income helps to offset the higher debt ratio.
If you have a low debt ratio, on the other hand, you only need to meet the basic residual income requirements for your area and family size. Some lenders use 41% as the cut off for the maximum debt ratio, while others allow you to go up as high as 43% before they expect more residual income in order for you to qualify.
Other Qualifying Factors
Aside from the residual income and debt ratio requirements, the VA does have some more requirements that you must meet in order to get approved for a VA loan:
- 620 credit score – This may vary by lender as each lender can set their own requirement
- Stable income/employment – You must prove that you can easily afford the mortgage payment with your stable income and employment that will continue for the foreseeable future
- No recent foreclosures or bankruptcies – If you filed for bankruptcy or lost your home to foreclosure, you must wait at least 2 years before you can apply for a VA loan again
The VA has relaxed guidelines and even offers veterans 100% financing. It’s a great way for veterans to buy a home, just watch out for those residual income guidelines as they are enforced. The residual income guidelines are a great way to make sure that you can comfortably afford the loan, though, rather than putting you in a position of getting in over your head. It’s for your own protection, as it will help you comfortably become a homeowner that earns equity in their home.