Residual income is a critical component of the VA loan approval process, but it’s often misunderstood.
Unlike traditional income requirements, residual income takes a more holistic view of a borrower’s financial situation, ensuring that veterans and their families have sufficient funds to cover everyday living expenses after paying their mortgage and other debts.
In this guide, we will delve into the intricacies of VA loan residual income, how it is calculated, its significance in the VA loan process, and related topics to help you better understand this important aspect of VA home loans.
What is Residual Income?
Residual income, in the context of VA loans, refers to the amount of income that remains after all major expenses have been paid.
This includes mortgage payments, property taxes, insurance, and other significant monthly obligations like car loans or student loans. The purpose of residual income is to ensure that veterans have enough money left over each month to cover their basic living expenses, such as food, clothing, transportation, and other personal needs.
Key Points:
- Residual Income Definition: The leftover income after paying all major debts.
- Purpose: To ensure borrowers can meet daily living expenses and avoid financial strain.
- Comparison with Debt-to-Income Ratio (DTI): While DTI focuses on the proportion of debt to income, residual income assesses whether enough income remains for daily living needs.
VA Loan Residual Income Requirements
The Department of Veterans Affairs has set specific residual income requirements based on the borrower’s location, family size, and the loan amount.
These requirements vary across different regions of the United States, reflecting the varying cost of living in different areas.
VA Residual Income Requirements by Region and Family Size
| 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 |
| 6 or more | +$80 per additional member | +$80 per additional member | +$80 per additional member | +$80 per additional member |
Notes:
- The figures above are subject to change and should be confirmed with the latest VA guidelines.
- The cost of living adjustment ensures that veterans in more expensive areas are not unfairly disadvantaged.
Calculating Residual Income
To calculate residual income, you need to consider the total monthly income and subtract all mandatory expenses, including the proposed housing expense (mortgage principal and interest, taxes, homeowners insurance), debts, and any other regular obligations. Here’s a simplified example:
Example Calculation:
- Total Monthly Income: $5,000
- Mortgage Payment (including taxes and insurance): $1,500
- Car Payment: $300
- Student Loan: $200
- Credit Card Payments: $150
- Total Mandatory Expenses: $2,150
- Residual Income: $5,000 – $2,150 = $2,850
This $2,850 must meet or exceed the VA’s minimum residual income requirement based on the borrower’s location and family size.
Why Residual Income Matters
Residual income is a crucial factor in the VA loan process because it provides a safety net for borrowers. By ensuring that veterans have enough income left over after meeting their debt obligations, the VA reduces the risk of default and helps veterans maintain a good quality of life.
Advantages of Residual Income:
- Financial Security: Residual income acts as a buffer against financial hardship, ensuring that veterans can cover unexpected expenses.
- Loan Approval: Lenders are more likely to approve a loan if the borrower’s residual income meets the VA’s guidelines.
- Improved Quality of Life: Veterans who meet residual income requirements are less likely to experience financial stress, contributing to overall well-being.
Residual Income vs. Debt-to-Income Ratio (DTI)
While residual income and DTI are both used to assess a borrower’s financial health, they serve different purposes. The DTI ratio measures the percentage of a borrower’s gross monthly income that goes toward paying debts, while residual income focuses on the amount of money left after all major expenses.
Comparison Table: Residual Income vs. DTI
| Criteria | Residual Income | Debt-to-Income Ratio (DTI) |
|---|---|---|
| Purpose | Ensures sufficient funds for living expenses | Measures the percentage of income used for debt payments |
| Calculation Basis | Total monthly income minus mandatory expenses | Total monthly debt payments divided by gross monthly income |
| VA Loan Requirement | Yes, specific to VA loans | Yes, but can vary based on lender guidelines |
| Impact on Approval | High residual income can improve chances of approval | A lower DTI ratio improves chances of approval |
Factors Affecting Residual Income
Several factors can influence a veteran’s residual income, including:
- Income Sources: All stable and reliable income sources, such as salary, disability payments, and retirement income, can be included in the calculation.
- Debt Obligations: High levels of debt reduce residual income, so managing debt effectively is crucial.
- Family Size: Larger families have higher living expenses, which can reduce residual income.
- Geographic Location: Cost of living varies by region, impacting the amount of residual income required.
Tips to Improve Residual Income
Improving residual income can make it easier to qualify for a VA loan. Here are some strategies:
- Reduce Debt: Paying down credit card balances, car loans, and other debts can increase your residual income.
- Increase Income: Consider additional income streams, such as part-time work or freelance opportunities.
- Budget Wisely: Reducing unnecessary expenses can free up more of your income for savings and essential costs.
- Refinance Existing Loans: Lowering interest rates on existing debts through refinancing can reduce monthly payments and improve residual income.
Related Topics: The VA Loan Funding Fee and Closing Costs
In addition to residual income, veterans should be aware of other costs associated with VA loans, such as the VA loan funding fee and closing costs. Understanding these expenses can help veterans better prepare for the financial obligations of homeownership.
VA Loan Funding Fee:
- Purpose: The funding fee helps sustain the VA loan program, allowing it to continue offering favorable terms to veterans.
- Amount: The fee varies depending on factors like down payment size and whether the borrower is using their VA loan benefit for the first time.
- Exemptions: Veterans with service-connected disabilities may be exempt from paying the funding fee.
Closing Costs:
- Components: Closing costs can include appraisal fees, title insurance, and loan origination fees.
- Negotiation: Some closing costs can be negotiated or paid by the seller, reducing the upfront costs for the borrower.
VA Loan Funding Fee Rates (2024)
| Loan Type | Down Payment | First Use | Subsequent Use |
|---|---|---|---|
| Purchase and Construction Loans | None | 2.3% | 3.6% |
| Purchase and Construction Loans | 5% or more | 1.65% | 1.65% |
| Purchase and Construction Loans | 10% or more | 1.4% | 1.4% |
| Refinancing Loans | N/A | 2.3% | 3.6% |
The Bottom Line
Understanding and managing residual income is vital for veterans seeking to secure a VA loan. This metric not only influences loan approval but also plays a crucial role in ensuring financial stability and well-being.
By effectively managing income and debt, veterans can meet the VA’s residual income requirements and achieve their homeownership goals.
In addition to residual income, veterans should be aware of other costs associated with VA loans, such as the VA loan funding fee and closing costs. Being well-informed about these aspects will help veterans navigate the VA loan process with confidence and secure the best possible terms for their mortgage.
