When it comes to risk analysis it’s not always easy to explain how things are done in the mortgage industry, but today we’re discussing a rule that doesn’t require any technical underwriting knowledge, a little common sense will do. It is VA’s guideline regarding residual income.
Residual income is the amount a borrower has left each month after revolving and installment debts, payroll deductions, maintenance, utilities, and certain other obligations are subtracted.
Perhaps the best way to illustrate this is to have you actually underwrite a loan (blink twice, you now have the power to Approve or Deny a loan application). Let’s say you have a 17 year old son named Tim, who’s a senior in high school. He’s a good, responsible kid who works hard, maintains excellent grades, and more often than not, tries his best to meet your expectations. Tim thinks of himself as independent and receives no allowance. He works a few hours on Saturday and Sunday at the local farmers market and earns $320 per month in gross pay. In addition, he’s held a job for the last three summers and has $3,600 in savings.
Predictably, Tim approaches you about buying a car, having found a great deal on a used Honda Civic. It’s in good condition with reasonable mileage for its age, and the owner is asking $6,000. Tim proposes a scenario in which he’d put up his $3,600 savings if you loan him the additional $2,400 to buy the car. Because he’d like to pay you back in a year, Tim suggests payments of $200 monthly until the debt is fully repaid.
Like any good underwriter, consciously or not, you consider the C’s: capacity, cash, collateral, and character/credit. Overall it’s a pretty decent loan application for someone that’s seventeen. He’s shown responsibility and the discipline to save. He’ll have some skin in the game in the form of his $3,600 savings as down payment. Tim doesn’t have much of a credit history, but you’ve never known him to break his word. And you’ll have some collateral in the form of the car.
But there are two areas of concern: Tim’s cash and Tim’s capacity. In terms of cash, after the $3,600 down payment is made, he won’t have any. No rainy day fund. In terms of capacity, his weekend job pays $320 per month, but he brings home $240 (75% of his gross pay). If he’s paying you $200 per month toward the $2,400 you loaned him, he won’t have enough left over to buy gas, eat lunch, pay for the car’s insurance and maintenance, or even treat himself to a movie or ballgame. Tim’s residual income (again, what’s left over after he pays all his bills) is insufficient, and he’ll have no savings. You love your son, and overall you think he’s responsible enough to have his first car; but if you agree to this deal, you are setting him up to fail (we lenders call it defaulting on the loan). This would be unfair to you and to him. How long would it be before he fails to make the $200 payment because the insurance is due or the vehicle needs a repair?
Congratulations! You’ve just underwritten your first loan and much to your chagrin, based on the terms Tim proposed, I’m sure you said NO!
Hopefully you now understand why VA has a residual income guideline. Though a bit more complicated, in principle the process is similar to the way we just underwrote Tim’s loan.
VA requires us to start with your gross income and deduct the following: 1) Housing related expenses such as principal, interest, taxes, insurance, HOA dues, Mello Roos, etc.; 2) Estimated expense for maintenance and utilities (based on a factor that VA provides); 3) Amounts taken from gross pay (payroll deductions); and, 4) Other payments you’re responsible for making (such as credit card and car payments, child support, child care, etc.).
What’s left is the amount you have available for expenses such as gas, car insurance, life insurance, Cable/HBO/Cinemax, health club memberships, cell phone bills, Wi-Fi, groceries, lunch, dry cleaning, kid’s lunch money, toiletries, entertainment, incidentals, and so on.
So how much residual income does VA suggest? It’s based on your family size and the region of the nation in which you reside. See the table below:
Table Of Residual Income By Region
The table below is for loan amounts of $80,000 or more.
Add $80 for additional family members up to seven.
| 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 |
Please note that throughout this post I’ve indicated this is a guideline. That’s because it’s not an inflexible requirement, but is considered in conjunction with other loan factors such as your debt-to-income ratio (though different there is a relationship between the two—one can change the other). Keep in mind that these calculations can get rather technical. Your Sidwell Mortgage professional is thoroughly experienced with VA loans and will perform the calculations and answer any questions.
We’ll see you at the next Post.