Hello, and thank you for joining me. My name is Fernando Zoota and I am your host for the podcast and blog, Non-QM Insider, the show where we talk about regulations, guidelines and anything having to do with non-qualified mortgages. The topic of discussion today is residual income. Let’s get into it.
I usually never get a question about residual income from a loan originate or a mortgage broker. The subject will often comes up when a borrower is applying for a veteran’s affair loan most commonly known as a VA loan. However, nowadays many non-QM lenders employ a residual income test.
Let’s start by defining residual income. The actual definition of the word “residual” is remaining after the greater part or quantity has gone. Residual income is the level of income that a borrower has after the deduction of all personal debt and expenses have been paid. So, what is the test? It’s a mathematical formula;
gross income – liabilities & household cost = residual income.
Let’s review the components of the formula. Gross income is easy, it’s calculated on all loans. It’s how much money is earned before you take out taxes. Liabilities are listed on the 1003 application. They’re combined with the home’s principle, interest, taxes and insurance (PITI) to determine liabilities used in the calculation. Household costs, what’s that? That’s the X Factor. Household cost equal $1500 plus $500 for the first child and $250 for each additional child up to $1500. Five children Max out the household cost calculation. After you subtract liabilities & household costs from the gross income, in order to pass the residual income test, you must show you have at least $1 extra.
Let’s give an example. Bob is married and has two children. He works at Computer Corporation and makes $8000 a month. He wants to purchase a new home and his proposed PITI is $2750. He has a $500 car payment and a $30 credit card.
- Liabilities: $2750 + $500 + $30 = $3280
- Household Cost: $1500 + $500 + $250 = $2250
- Residual Income: $8000 – ($3280 + $2250) = $2470
This borrower passes the residual income test.
Let’s look at another example. Devin is unmarried and has no children. He works at Walmart and makes $2300 a month. He wants to purchase a new home and his proposed PITI is $984. In addition, he has a car payment of $165.
- Liabilities: $984 + $165 = $1149
- Household Cost: $1500
- Residual Income: $2300 – ($1149 + $1500) = -$349
This borrower fails the residual income test.
What’s the lesson learned between these two examples? The lesson is residual income test are an issue for borrowers with lower than average incomes. I can’t tell you with certainty that there’s only one residual income test. I’ve shared with you the most common residual income test or the one I continually see, but there may be others. If the subject comes up, you’ll have to ask your account executive or underwriter, for their residual income test.