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Lesson 4.6

VA Loan Preapproval

 
Barby Wulff | Mortgage Expert | NMLS #177100

Why Preapproval is So Important

Mortgage preapproval is incredibly important in today’s homebuying environment. Getting preapproved shows sellers and real estate agents you’re a serious and strong homebuying candidate. Some listing agents won’t accept a purchase offer from buyers without a copy of their preapproval letter.

Preapproval also gives buyers a clear sense of their purchasing power and what it’ll take to get to closing day. To be sure, loan preapproval isn’t any kind of guarantee of financing. Loan preapproval and loan approval are two very different things. But with loan preapproval you’ll know what you can afford under realistic financial conditions and be able to make a strong offer without stretching yourself too thin.

Preapproval is a more detailed process than prequalification. Other than pulling your credit reports, lenders basically rely on your word and your best estimates during the prequalification conversation.

During the preapproval process, lenders want to verify information. You’ll typically need to provide financial documents like pay stubs and bank statements and sign non-binding forms and paperwork. Lenders will be looking at cold, hard numbers and creating the most realistic picture possible of your purchasing power.

This is one area where you have a lot of control – the faster you return paperwork, the faster your loan process moves.

Common Document Needs

Here’s a look at some documents you may need to provide or give a lender permission to obtain:

  • Copy of government-issued photo ID, typically a driver’s license
  • Copy of DD-214 for veterans; some National Guard and Reserve veterans may need to provide points statements or similar paperwork
  • Statement of service letter signed by commanding officer; there isn’t a standard form for a statement of service, so talk with your loan officer about what information to include

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  • Copy of recent pay stubs and last two years’ worth of W-2 statements
  • Federal tax returns for the last two years if you have income from self-employment, 1099s or rental income
  • Copy of most recent bank statements
  • VA awards letter documenting VA disability percentage and monthly income amount
  • Social Security awards letter documenting monthly income amount
  • Copy of most recent retirement account statement
  • Copy of divorce decree or court papers specifying alimony or child support obligations
  • Child care statement explaining why you don’t have monthly child care expenses or detailing the monthly cost

VA lenders generally rely on an “Automated Underwriting System,” or AUS, to determine a buyer’s preapproval status. An AUS is a computer program that instantly evaluates a buyer’s eligibility, based on a variety of factors.

Not every qualified borrower will obtain AUS approval. In those cases, lenders will consider a “manual underwrite,” which is a more involved process that typically utilizes more stringent requirements.

Here’s a look at some of the key factors involved in VA loan preapproval:

Credit Score

Credit is a make-or-break financial indicator. Credit score benchmarks for VA loans can vary by lender and other factors. Many VA lenders are looking for a minimum FICO credit score of 620.

If your credit score falls short, please consider the complimentary credit-strengthening services offered by our incredible Lighthouse Program.

The credit experts at Lighthouse work with veterans, service members and their families for free to develop a plan to repair their credit and get on the path to loan prequalification. Our Lighthouse Program has helped more than 17,000 people go on to boost their credit and close on a home loan.

You can talk with a Veterans United loan officer about your credit profile and the Lighthouse Program at 855-259-6455.

Income & Employment

You don’t need a job to secure a VA loan – just ask retirees. It’s more an issue of whether you have stable, reliable income that’s likely to continue. There’s an array of income types, and some are more stable and reliable than others.

For most VA borrowers, their primary income source is a job, whether it’s serving in the military or working in the civilian world.

A solid employment history says a lot about your ability to repay a loan. The gold standard of employment for many lenders is two years of reliable, full-time employment, ideally with the same employer. But real-world resumes aren’t always this pristine.

That’s why the VA and lenders allow flexibility when it comes to employment standards. There are no clear-cut “pass/fail” employment criteria. Rather, each applicant is considered on an individual basis, with a focus on three key measures:

  • Is employment reliable?
  • Is employment likely to continue?
  • Is employment income sufficient in amount?

Let’s take a look at a few employment scenarios:

Full-time workers employed less than two years

It’s certainly possible for applicants to earn VA loan approval if they have been employed for less than two years. If you have less than two years of full-time employment under your belt, a lender may take a careful look at these indicators:

  • Your MOS and past employment record, including length of time at other jobs
  • Your training, education and qualifications for your current job
  • Your employer’s confirmation that your job is likely to continue

Applicants with less than one year of employment will have a tougher time earning VA loan approval. But exceptions can be made, so talk to a lender about your specific situation.

Continuity is often key in these cases. For example, veterans who recently separated from military service obviously won’t have two years on the job. But that may not matter if lenders are satisfied there’s sufficient continuity between their MOS and their new employment.

There’s pretty obvious continuity when a former MP takes a job as a civilian police officer. Things get murkier if that MP is now a computer programmer or a general contractor.

With a short job history, you’ll need to do all you can to impress a lender. Make sure you satisfy all other VA loan requirements. Provide a letter of explanation from your current employer showing that your job is stable and likely to continue.

  • You can make it happen today!

Part-time employment

Part-time employees typically need a two-year history to count that income toward mortgage qualification. Borrowers without that two-year history of part-time income may be able to use the income to offset other debts.

Guidelines and requirements can vary by lenders.

Read more about how to count part-time income toward VA loan preapproval.

Self-employment

Self-employed applicants usually need to document their income on two years of tax returns in order to count it toward VA mortgage qualification. There can be some exceptions, and policies and guidelines on counting self-employment income can vary by lender.

Also, note that lenders can only count income on which you pay taxes, meaning write-offs, or unreimbursed business expenses, will be averaged and deducted from your total income.

Read more about how to count self-employment income when pursuing a VA home loan.

Commission and overtime income

Commission-based workers generally need to document at least two years of income. Anything less typically can’t be considered stable. If you’re paid on commission, you may need to provide a healthy amount of documentation to a lender, including:

  • The actual amount of commissions paid year-to-date
  • The basis for your commission (Are you paid a base salary plus commission, commission only, or periodic draws against commission?)
  • Your commission schedule
  • Your individual income tax returns for the previous two years

Having those two years spread among multiple employers may be fine, as long as the work is consistent.

The same is generally true for counting overtime income.

Talk with lenders about their policies and potential exceptions.

Military employment

Active duty service members can simply provide a recent Leave and Earnings Statement (LES) as a record of employment.

As long as your enlistment is expected to continue more than 12 months after your loan’s closing date, you should be set.

Read more about how VA lenders can count income and allowances for active duty military, National Guard members and Reservists.

Other income sources

There are additional sources of income that lenders can count as “effective income” toward qualifying for a mortgage, including some types of non-taxable income.

Some of those additional income sources may include:

Not all of these income streams are automatically acceptable. Lenders may want to see a proven track record of you receiving it, or have some kind of guarantee that you’ll continue earning it in the months and years ahead. Generally, you’ll need to show that sources of income like these will continue for at least another three years.

A big one worth mentioning is GI Bill income. Veterans can receive housing assistance through their education benefit. But VA lenders cannot count this as effective income toward a home loan. In fact, it’s difficult to find any lender or loan type that will.

Job Gaps & Job Changes

Having a gap in your employment history isn’t uncommon. But lenders will want to take a closer look if you’ve had some time without a job in the lead up to pursuing a home loan.

You may need to have been back to work for a certain number of months before lenders can move forward.

Changing jobs during or even right after the loan process can also affect your chances of closing.

You can read more about how job gaps and job changes an affect your VA loan eligibility.

VA Loans & Co-Borrowers

Having a co-borrower on the loan with you can be a tremendous benefit. Counting this person’s income can help you buy more house. But there are some restrictions and requirements that co-borrowers will need to meet.

That means there’s good and bad when it comes to co-borrowers. Just as a co-borrower’s income can help, this person’s credit and debt profile can also harm your loan approval chances. You may be separate people, but lenders will look at your loan application as a single entity.

Your co-borrower situation can also impact what kind of interest rates you get quoted. Lenders will typically quote a rate based on the lowest of the borrowers' credit scores. So if you have excellent credit but your co-borrower only has so-so scores, you're often stuck with so-so rate quotes.

This person will be legally and financially obligated on the loan. They’ll also typically need to occupy the home with you as their primary residence.

Lenders may also have limits on how many borrowers can be on a single loan. Veterans United currently allows up to four borrowers on a VA home loan.

Purchasing With a Non-Veteran Spouse

The most common co-borrower on VA loans is a non-veteran spouse. Your spouse will also need to meet the lender’s credit score requirement. In addition, lenders will include your spouse’s monthly debts and income when calculating your DTI ratio.

They’ll also take into account any derogatory credit, collections, foreclosures, bankruptcies or liens. That means a spouse's recent foreclosure or bankruptcy could mean you need to wait to pursue a VA loan.

Purchasing With Another Veteran

Another veteran who has VA loan entitlement can be a co-borrower, as long as this person will live in the home with you as his or her primary residence. They’ll face the same credit and financial scrutiny as a spouse. VA approval is required for this type of setup, unless the veteran happens to be your spouse. You can choose to use your entitlement solely in cases like this or opt for a “dual entitlement” scenario, with each eligible borrower utilizes a portion of their VA loan entitlement. It’s usually best to talk with a VA lender in more detail about how to proceed in cases like this.

Non-Spouse, Non-Veteran Purchases

What if your co-borrower isn’t a spouse or another veteran with VA loan entitlement?

These situations can present more of a financial challenge. These are known as “joint loans,” and not all VA lenders make them. Veterans United currently does.

On a joint loan, the VA’s guaranty applies only to the veteran’s half of the mortgage. Remember, the VA typically guarantees 25 percent of the loan to a lender. With a non-spouse, non-veteran on the loan, the guaranty is cut in half, to just 12.5 percent.

That’s a risk for lenders, which is why they’ll typically require a 12.5 percent down payment for a joint loan.

Common-Law Marriage

You may be able to count your common-law spouse's income on a VA home loan. State laws vary regarding common-law marriage, so talk with a lender for more details.

Community Property States

In some cases, lenders can count your spouse's debts and negative credit history against you even if they're not going to be on the home loan.

VA buyers in the nation's nine community property states don’t have the option of simply forgetting their spouse’s debt. Those states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin.

Talk with a Veterans United loan specialist at 855-259-6455 for more details if you're buying in one of the nine community property states.

Debts

Lenders are going to look at your major recurring debts as part of their assessment. They’re considering housing payments, student loans, car payments, child support payments and other consistent expenses. They’ll also look at things like collections, judgments and other forms of “derogatory credit.”

Generally, you don’t need to be debt-free to qualify for a VA loan. Lenders are looking for a healthy balance between monthly debt and monthly income. But some types of debt are worse than others.

Derogatory credit

Having accounts in collection, judgments against you and liens can all hurt your ability to qualify for or close on a home loan. Lenders will often have a limit on how much derogatory credit a potential borrower can have. This cap on derogatory credit might be $5,000 or $10,000 or more. It can vary by lender, and there may be exceptions in certain cases.

For example, some lenders ignore collections on your credit report if you’re actively working to pay the debt and can document on-time payments for the last 12 months. Some might also ignore charge-offs, which are essentially bad debts at least six months past due that creditors have written off.

But federal debts and delinquent accounts can be especially problematic. VA lenders will run your name against the Credit Alert Interactive Voice Response System (CAIVRS). This specialized database tracks current delinquencies and defaults within the last three years on things like federal student loans, FHA loans and other federal programs.

Federal agencies that report to the CAIVRS database include:

  • Department of Education
  • Department of Housing and Urban Development
  • Department of Agriculture
  • Department of Justice
  • Small Business Administration

Problems with student loans and FHA loans are two of the most common reasons prospective borrowers wind up in this database. With student loans, for example, getting on a repayment plan can help speed the process if you’re unable to repay the government in full. If you default on an FHA loan, you won’t typically have a clear CAIVRS until you’re three years removed from when the government pays the foreclosure claim.

Whatever the reason, you won’t be able to close on a VA loan until you have a “clear” CAIVRS.

CAIVRS doesn’t track data from the Internal Revenue Service, but federal tax liens will usually appear on a borrower’s credit reports. Tax liens can also make it tough to obtain home financing.

Income taxes

Notify your loan officer if you haven’t filed income taxes in the last two years. Lenders will look to obtain your tax transcripts directly from the IRS in order to verify your income and financial information.

Contact your loan officer immediately if you have not filed taxes for either of the past two years, even if you have received an extension from the IRS. If you haven’t filed tax returns because you receive non-taxable income, you may need to obtain a verification letter of non-filing from the IRS.

Tax liens

The IRS can place a lien on your property or your assets if you don’t pay your federal income taxes. Having an active lien can make it more challenging to secure home financing. Ideally, you can pay the debt before starting the homebuying process. But that’s not always possible.

Different lenders can have different policies when it comes to tax liens. But you may be able to move forward with a current tax lien if:

  • You’ve entered into a repayment plan with the IRS and have at least a three-month history of on-time payments
  • You can meet the debt requirements for the lender and the loan type with that monthly repayment included
  • You note the tax lien on Page 4 of the standard mortgage loan application

Still, there are no guarantees. In fact, would-be borrowers with active tax liens may also encounter tougher lending requirements.

A tax lien often means lenders can’t process your loan file through an Automated Underwriting System (AUS), which means your file would require “manual underwriting,” as it’s known. Manual underwrites typically come with tougher lending requirements.

Talk with lenders in more detail if you’re hoping to land a home loan with a tax lien in the mix.

Debt-to-Income (DTI) Ratio

The VA doesn’t set an income threshold for potential borrowers. You don’t have to make a certain amount per hour, month or year to qualify for financing. Instead, one way the VA and lenders evaluate what you can afford is by comparing what you spend each month to what you earn. This calculation is known as a debt-to-income (DTI) ratio.

Mortgage lending generally involves two types of ratios, a “front-end” ratio that compares only the new housing cost to your monthly income and a “back-end” ratio that looks at all of your major monthly expenses. VA loans focus solely on the back-end ratio.

Lenders will calculate your major monthly debt, including housing, loans, child care and other significant expenses. That figure is divided by your total monthly gross (pre-tax) income. Only certain types of debts and income count toward your DTI ratio. VA lenders will focus on your major revolving and installment debts, mostly pulled directly from your credit reports. But they can also consider other obligations that don’t make your credit report, like child-care costs, alimony and even commuting expenses.

Here’s an example:

Debt-to-Income Ratio Calculation
Debts Amt
New mortgage payment $1,000
Auto loan $200
Student loan $100
Child support $100
Total monthly debt $1,400
Total monthly gross income $3,500
Debt-to-Income ratio ($1,400 divided by $3,500) 40%

If you have collections or charge-offs on your credit report, lenders won’t typically factor those into your DTI ratio calculation unless you’re making regular monthly payments on those debts. But lenders may have a cap on how much of this derogatory credit you can have.

The VA wants to see borrowers with a DTI ratio of 41 percent or less. It’s definitely possible to be above that threshold and still obtain VA loan approval. But you’ll need to meet a higher benchmark for residual income (we’ll explain this unique financial standard next) and fall within a lender’s cap for DTI ratio. Those can and will vary depending on the lender and other factors. High DTI borrowers may be able to improve their loan chances with solid “compensating factors,” which are strengths like great credit, solid assets and other positive attributes.

What happens if your DTI ratio is too high for lenders? There are a few possible solutions. One is to find more income, which is easier said than done. Two is to pay down debts or eliminate them completely, which can also be tough. Three is to seek a lower loan amount. A good chunk of your DTI ratio will be based on your projected monthly mortgage payment.

Residual Income

Despite the $0 down payment benefit, VA loans have been the safest mortgage on the market for much of the last decade. One of the big reasons why is the VA’s unique financial requirement for discretionary income, which it calls “residual income.”

VA borrowers must have a minimum amount of money left over each month after paying their major expenses. The amount varies based on your family size and where in the country you’re buying. The aim is to make sure borrowers have enough discretionary income to cover everyday needs like gasoline, groceries and medical bills.

To calculate your residual income, a lender will simply subtract your major monthly debts from your gross monthly income. You may be able to omit a spouse or dependent from the calculation if they’re not on the loan and have verified income to support themselves. Also, lenders may be able to reduce the residual income requirement by 5 percent for active duty borrowers, because on-base goods tend to be cheaper.

Here’s a look at the VA’s current residual income guidelines:

For loan amounts of $80,000 and above
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

If you have more than five in your household, add $80 per family member up to a family of seven.

Based on the chart, a family of four living in the Northeast would need at least $1,025 available each month after paying the mortgage and other significant expenses. Veterans and service members who fail to meet that residual income standard will have a hard time obtaining a loan.

Prospective borrowers with a DTI ratio above 41 percent must exceed their residual income requirement by 20 percent. To continue the example, that same Northeastern family of four would now need $1,230 in residual income to satisfy the requirement.

There’s a fixation on debt-to-income ratio in the mortgage industry. But residual income may be a more powerful and realistic metric way to look at affordability and a borrower’s ability to stay current on their mortgage if emergencies arise. It’s also a big reason why VA loans have such a low foreclosure rate, despite the fact that 9 in 10 people purchase without a down payment.

Preapproval Letters

That’s a snapshot of some of the major considerations of VA loan preapproval. The goal of this process is to obtain what’s known as a preapproval letter. It’s an increasingly important document in housing markets nationwide.

Loan preapproval is not a guarantee of financing. But it’s a significant step that real estate agents and sellers love to see. It showcases a lender’s confidence in your ability to handle a home loan.

The preapproval letter will typically list a series of conditions that need to be met in order for the loan to move forward. These conditions help protect both lenders and borrowers in case things don’t go as planned or financial circumstances change.

As you can see, this example preapproval letter lists six contingencies that may need to be met, including an acceptable appraisal, verification of the borrower’s VA loan entitlement and final approval from our underwriters. Your loan officer will explain these conditions in detail.

Most preapproval letters also make clear that changes to your credit, income or other important financial metrics can cause the document to expire. Again, loan preapproval is not the same thing as formal loan approval. It’s also not a binding step. You can seek preapproval from multiple lenders.

Would-be buyers often ask: How long is my preapproval good for? Some lenders date their preapproval letters, while others don’t. Credit, income and asset documentation may need to be reordered or resupplied after a few months. In some respects, the expiration doesn’t matter a great deal, as preapproval isn’t binding or a guarantee of financing. Lenders are going to verify your income, employment and credit information again once you’re under contract on a home.

Some lenders may allow you to alter the date and the preapproval amount (up to your max) in order to craft a strong offer without tipping your hand. You might be preapproved for a $300,000 loan, but it may not be in your best interest for home sellers to know how high you can go.

While this document isn’t any kind of guarantee, a preapproval letter gives you a clear sense of what you can afford and what it will likely take to land a VA home loan. Loan preapproval also gives you the confidence and clarity to start seriously shopping for your home. Sellers and their agents will be looking for this.