Residual income

Key Takeaways

• Residual income is the dollar amount a household has left each month after the housing payment, other debts, taxes, and maintenance are covered.
• VA underwriting uses two primary standards, the debt-to-income ratio and residual income analysis, under 38 CFR 36.4340.
• When a veteran's debt-to-income ratio is above 41 percent but residual income exceeds the guideline by at least 20 percent, no second level review or written justification is required.
• Residual income guidelines vary by household size, by region, and by whether the loan is under $80,000 or $80,000 and above, so there is no single dollar figure to memorize.

What It Means

Residual income is the money a household has left each month after the housing payment, other debt payments, taxes, and estimated maintenance and utilities come out of take-home pay. It is a cash-flow test measured in dollars, not a percentage test, and that is what separates it from the ratios most borrowers hear about first.

A Debt To Income Ratio answers one question: what share of gross income goes to debt? Residual income answers a different one: once everything is paid, is there enough left to feed and clothe this household? A couple with a 45 percent ratio and $1,800 left over may be in better shape than a family of six with a 38 percent ratio and $600 left over. A ratio cannot see that difference. Residual income can.

The VA built its underwriting around this idea and treats residual income as a primary standard rather than a secondary check, which is part of why a veteran can qualify with no Down Payment and still be a sound credit risk. FHA underwriting leans the other way, running loans through the TOTAL Scorecard and weighting the ratio more heavily.

How It Works in Washington

Washington sets no residual income standard of its own. The numbers are federal, and the Washington law that matters to a licensee is about staying in your lane.

On the federal side, 38 CFR 36.4340 states that the two primary underwriting standards used to judge the adequacy of a veteran's present and anticipated income are the debt-to-income ratio and residual income analysis. The regulation's residual income guidelines are drawn from the Consumer Expenditure Survey published by the Bureau of Labor Statistics, count all members of the household, and are published as regional minimums for loan amounts up to $79,999 and for loan amounts of $80,000 and above. Residual income also appears in the federal ability-to-repay rule at 12 CFR 1026.43(c)(2)(vii), which lists the consumer's monthly debt-to-income ratio or residual income among the items a creditor must consider. That same section is where the Qualified Mortgage standards live.

For a Washington broker, RCW 18.86.030(2) is the guardrail. Unless otherwise agreed, a broker owes no duty to conduct an independent investigation of either party's financial condition and no duty to verify statements from a source the broker reasonably believes to be reliable. RCW 18.86.050(1)(c) points the same direction, requiring a buyer's agent to advise the buyer to seek expert advice on matters beyond the agent's expertise. Do not run residual income math for your buyer. Send them to the loan originator.

Example

Staff Sergeant Alicia Bowen is buying a $525,000 house in Lakewood with a VA loan and no down payment. Her household is four people. Gross monthly income is $8,400 and take-home pay is $6,700. Her proposed housing figure, including principal, interest, taxes, insurance, and the utility and maintenance estimate, is $3,900. She also has a $520 car payment and $180 in student loans.

Her debt-to-income ratio is $4,600 divided by $8,400, or 54.8 percent, well above 41 percent, so on ratio alone she looks marginal. Her residual income tells a different story: $6,700 minus $3,900 minus $700 leaves $2,100 a month. If the VA guideline for a four person household in her region at her loan size is $1,400, her residual income exceeds the guideline by 50 percent. Because that clears the 20 percent cushion in 38 CFR 36.4340, the underwriter needs no second level review and no written statement of justification.

Common Mistakes and Exam Traps

• Residual income is a dollar amount left over each month, not a percentage. Any answer choice that states it as a ratio is wrong.
• The 41 percent VA debt-to-income figure is a guideline, not a hard cap. A loan above 41 percent can still be approved, and a loan under 41 percent can still fail the residual income test.
• Residual income guidelines change with household size, region, and loan amount, so a single memorized dollar figure will not answer the question.
• Residual income is measured against take-home pay after the housing payment and other obligations, while the debt-to-income ratio is measured against gross income.