For about a decade, the percentage of VA loans in foreclosure has steadily been the lowest amongst all mortgage types. It is a success story that has hit the headlines several and sees no sign of abating.
For lenders, VA mortgages are the safest. No questions asked.
This appears to be an anomaly but really isn’t. VA loans require no down payment, which seems to fly in the face of conventional wisdom that lower equity equals higher default rate. Also, credit requirements are less strict than on alternative mortgage types.
But these features aren’t responsible for the stability and safety of the VA program. An amalgam of astute factors is the reason why. One of the best-known factors that are fairly unique to the VA program, by the way, is its home retention service.
It is a sharply driven intervention plan by VA officials in at-risk mortgages at the brink of foreclosures. Since the mortgage crash, these efforts have saved in excess of 500,000 VA homeowners from foreclosing on their property. In 2015 alone, more than 90,000 avoided foreclosure thanks to these VA specialists.
Another major factor is making sure from the get-go that a military borrower would be able to afford the mortgage over time. This heavy take on affordability takes a multi-faceted, holistic approach, which this article will expound pedantically.
Of course, it revolves around the income amount, but it is also relative to the type of income, outstanding debts, and future income prospects.
Why VA Income Checks Are Necessary
The short answer is for lenders to get a full picture of the ability of a borrower to handle mortgage payments.
It is as much a protection for lenders against high default rates that’d negatively impact their business, as much as it is a protection for borrowers against expensive mortgages that they can’t afford to pay off in the long run, which would otherwise set them up for the heartaches of foreclosure and a heavy hit on their credit.
A thorough income check is effectively a win-win guideline.
What VA Loans Income Requirements Entail
The variety of income types VA lenders accept is diverse. However, a major requirement is that the income MUST originate from full-time employment.
By full-time employment, lenders stipulate a minimum of 30 working hours per week.
This requirement does not explicitly target employees of traditional employers. Self-employed individuals also qualify as long as the income from their self-employed has a history of at least TWO (2) years.
Lenders would look at your most recent federal income tax returns to ascertain qualified income. Furthermore, lenders mostly desire self-employment income that shows a substantial increase on a year-to-year basis.
But what happens when you don’t have full-time employment with a traditional employer or self-employed full-time? A lender may use part-time income if it is “consistent.”
Lenders want to be sure that the part-time income has a TWO (2) year history, and you are likely to continue earning it for at least the next THREE (3) years.
In addition to part-time income, lenders may accept other income sources such as a pension, dividends, or interest as long as the same rules of consistency apply to them.
VA Qualifying Income Types
- Salary/W-2 Income
- LES stipulated military income
- Self-employed Income; defined as income from ventures in which the borrower has at least 25% ownership interest. Used only when it follows the stated rule of consistency. Borrower MUST provide:
- Personal tax returns going back TWO (2) years (include all schedules)
- K-1, 1120, or 1120S when applicable
- Balance sheet and year-to-date profit/loss statement
- Signed 8821 or 4506 forms; to aid the lender in requesting copies of your income tax returns from the IRS.
- Second Job; only used when it follows stated rule of consistency
- Bonus or Overtime Income; only used when it follows the stated rule of consistency. Lenders use the average of the last TWO years of income received.
- Part-time Income; only used when it follows the stated rule of consistency.
- Seasonal employment; stated rule of consistency relaxed to TWO (2) years of history and simply demonstrating the strong likelihood of getting back to work after each employment lapse.
Rental Income; subject to the following guidelines
- Income from boarders or roommates in a single-family property that the borrower will occupy doesn’t count.
- The rental agreement on the rented property; or
- Tax returns showing actual rents that go back TWO (2) years
- The borrower may be required to provide proof of experience as a landlord and reserve containing three months of rental property mortgage payment shown through bank statements.
- Commission; lenders use the average of the last TWO years of the commission received. The borrower must subtract business expenses not reimbursed from gross income.
- Interest and Dividends; stated rule of consistency relaxed to only demonstrating TWO (2) year history of receipt. Excludes dividend re-investment plans and MUST be accompanied by a demonstration of substantial asset reserve available after closing the mortgage.
- Notes Receivable; stated rule of consistency relaxed to a minimum of 12 months history and SHOULD NOT expire within THREE (3) years. Lenders will use it as a compensating factor if it expires within THREE (3) years.
- Child Support, Alimony, or Separate Maintenance; Lenders do not require borrowers to disclose this income type. However, borrowers are at liberty to use this income with the following guidelines:
- Provide a copy of divorce decree and child support order, when applicable
- Demonstrate timely payment for the past TWELVE (12) months
- Demonstrate that timely payment will continue for a minimum of THREE (3) years
- Retirement/Social Security Income; stated rule of consistency relaxed to only ensuring that income MUST NOT expire within THREE (3) years.
Non-Qualifying VA Income Types
- Gambling or lottery winnings
- Unemployment compensation
- One-time performance bonuses
- Isolated payment from an employer
- Income from non-occupying co-borrowers
- Any income that has no consistent history nor verified likelihood of continuance
VA Loan Income Limit
The USDA mortgage program that specifically targets moderate-, low- and very-low-income families in rural areas logically has an income ceiling, beyond which a borrower doesn’t qualify.
The VA loan program doesn’t have a ceiling of this kind (same as the FHA loan program). The VA only considers your income in the sense of it being a determinant factor of your ability to afford a mortgage, and nothing more.
Debt to Income (DTI) Ratio
You may have a large income. But if you have lots of outstanding debts, then you wouldn’t have enough left-over income to pay off new debts. This is the basic premise for lenders placing a premium on a borrower’s debt to income ratio.
The DTI ratio is, as the name implies, a comparison of your debts and your gross monthly income.
Types of DTI Ratio
Another name variation is the mortgage-to-income ratio. To compute this ratio, the lender divides the projected monthly mortgage payment by your gross monthly income. This projected mortgage payment typically includes the principal, interest, insurance, and taxes.
For example, if you earn $4,000 and intend to take a loan with a cumulative monthly payment of $1,000, then the MTI ratio is 25% ($1000/$4000*100).
This ratio brings all your current debt obligations (such as personal loans, car loans, and credit card debts) into focus, adds them to your projected mortgage, and then divides your cumulative monthly debt payments by your gross monthly income.
Note that household expenses, insurance, and utility payments typically do not count as debt.
While most major lending avenues, such as the FHA and USDA, use both fronts- and back-end ratios, the VA only uses the back-end ratio.
In general, the lower your DTI ratio, the higher your ability to afford a mortgage. Thus lenders interpret a high DTI ratio as a red flag.
Acceptable DTI Ratio on VA Loans
Technically there is no maximum VA loans DTI ratio. However, lenders set their own maximum DTI requirements. In general, VA lenders stipulate a DTI ratio maximum limit of 41%. However, this is not an absolute limit. In that, a higher DTI ratio only triggers additional layers of fiscal scrutiny. Thus, it is conceivable that borrowers with a higher DTI ratio may access VA mortgage in select cases.
This is on a case-by-case basis. And these borrowers would often possess compensate for higher DTI ratio with stronger factors such as excellent credit or more money in reserve.
Therefore, while a theoretical limit exists, lenders base approval decisions on thorough reviews of the entire financial situation of each borrower.
VA Residual Income
The DTI ratio computes the percentage of gross income, which the borrower would use for monthly debt payments. Residual income refers to how much money is left of a borrower’s monthly gross income after the borrower has paid off monthly debt payments, taxes, and housing expenses, utilities, other obligations (such as child support).
The amount that remains is your residual, disposable, or discretionary income. You’d use this disposable for typical family needs, such as clothing, food, gas, et cetera.
Not having a substantial residual income can make meeting all financial obligations difficult. Substantial residual income can serve as a cushion against late payments in the event of a crisis. Accordingly, lenders place a minimum limit on the residual income a borrower MUST have to qualify for a VA mortgage. However, unlike the DTI ratio limit, this limit is not uniform.
The residual income requirement for a borrower depends on:
- Location of the house the borrower intends to buy
- Number of people who would live in the home
- Loan size
VA Residual Income Chart
Northeast: Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont
Midwest: Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Wisconsin
South: Alabama, Arkansas, Delaware, D.C., Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, Oklahoma, Puerto Rico, South Carolina, Tennessee, Texas, Virginia, West Virginia
West: Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, Oregon, Utah, Washington, Wyoming
Table of VA Residual Incomes by Region
For loan amounts of $79,999 and below
Add $75 for each additional member up to a family of 7.
Table of VA Residual Incomes by Region
For loan amounts of $80,000 and above
Add $80 for each additional member up to a family of 7.
VA Residual Income and DTI Ratio
The method of calculation, as well as the nature of limits of residual income and DTI ratio, may differ. However, lenders consider them together rather than in isolation. Thus, the residual income limits in the chart above are for borrowers whose DTI is not above 41%.
Lenders require that borrowers with DTI of more than 41% have 20% higher residual income. For example, if the DTI ratio for a family of three in Oklahoma (South) is 44% (higher than 41%), the residual income requirement will be 20% higher than the standard requirement ($889), which is $1,067.
Note that the disposable income requirement for active duty service members is 5% less than the standard requirement for some lenders.
Your income is sizeable, your debts and residual income are within acceptable limits, but lenders still need to check one more box as regards income. It is stability.
A stable income ensures that you are able to make timely payments continually. To determine the likelihood of income continuance, lenders would request for employment verification going back two years. Lenders would demand a reasonable explanation for any employment gap noticed.
In certain instances, the lender may count time spent schooling for the borrower’s profession (such as nursing school) as part of the two-year guideline.
Furthermore, the lender will try to ascertain that you would continue to receive income from your stipulated job for at least the next three years after closing the loan.
However, if a borrower plans to retire within the first three years, the lender would perform income checks using expected post-retirement income, social security benefits, and similar income types. Lenders may also use allowances for seasonal employment as legitimate income sources in some cases.
When You Fall Short: Tweaking the Numbers
In some situations, borrowers may have metrics that do not meet acceptable guidelines, such as a high DTI ratio without corresponding high residual income. In these scenarios, loan officers may advise you to s
The loan officer would then tinker with the numbers until s/he identifies a sweet spot number that you can afford to repay whilst ensuring that you meet the necessary income and credit checks/guidelines.