The housing debacle of the past decade caused no shortage of grief across the country. While pockets were spared much of the onslaught of foreclosures, most parts of the U.S. were hit and hit hard. Today, while foreclosure filings appear to be waning, and that’s a good thing, there is still no shortage of finger pointing. The Dodd-Frank legislation created the Consumer Financial Protection Bureau, or CFPB, formed to create firewalls to make sure that such a crisis never again occurs.
Much of this is closing the barn door after the horses have already left and VA lenders today are reacting to an onslaught of mortgage regulations. In 2013, there were more than 200 new mortgage regulations that affected home loans of all stripes including FHA and conventional loans as well as VA mortgages.
During the throes of the housing boom easy money fueled housing prices and soon it seemed everyone was a real estate “investor.” Loans were issued to those with poor credit or hard to prove income. In essence, loans were made to millions that shouldn’t have been made in the first place. After the storm, an easy target was the zero down loan. In fact, legislators rattled their sabers seeking to require all borrowers to put down at least 20 percent. Legislators and others wanted some “skin in the game.”
But VA loans have had the highest performance rate of any mortgage loan. VA loans don’t require a down payment but VA borrowers pay their mortgages on time. That says that a zero down loan isn’t the problem, other things are. VA mortgages do require good credit and verified income as other loans do but they have always had the no down payment option.
What VA loans do require that others do not is residual income. Maybe that’s the reason for the low delinquency rates VA mortgages enjoy.
What is Residual Income?
Residual income is after-tax income that is left over after all credit obligations are paid. It’s residual. VA loans as others require a VA lender make sure the borrower can afford the new VA mortgage by calculating and documenting debt to income ratios but the VA also requires a specific amount of money left over each month.
Residual income amounts are established by the VA and can vary based upon the number of people in the household as well as the geographic location of the property identified as Northeast, Midwest, South and West. VA lenders refer to charts that identify which state belongs in which region. For example, Texas borrowers follow the South Region chart and Arizona loans refer to the West Region chart.
As an example, here are the residual income requirements for the Northeast Region:
Household size of One : $450
Household size of Two : $755
Household size of Three : $909
Household size of Four : $1,025
Household size of Five : $1,062
For each additional household member, add $80 up to seven.
When approving a VA loan application, VA lenders are required to refer to these charts to make sure there is enough residual income available to meet VA lending guidelines. The lender will verify monthly income with 30 days of pay check stubs, remove the withholdings then deduct all monthly credit obligations including the mortgage, property taxes, insurance, car payments and so on. If it’s on the credit report, it will be deducted from the income.
A Strong Compensating Factor
Solid residual income can allow a VA lender to issue a loan approval that might be “on the fence.” For example, the maximum debt to income ratio is 41 and the new “ability to repay” or ATR maximum is 43. A lender can make a determination to approve a VA loan where the debt ratio is higher if there are other compensating factors.
A compensating factor might be a high credit score or long term employment. But having a sizable residual income amount will have major impact as well. For example, if a couple’s residual income requirement in New York is $755 and the verified residual amount is three times that, a lender will likely approve the loan even though the debt ratio is higher than 41.