A key benefit of military service, Veterans Affaris (VA) home loans offer no-down-payment financing, no private mortgage insurance (PMI), and flexible credit criteria.
But while VA loans typically employ less-rigorous credit standards, make no mistake: Each applicant is still subject to a thorough evaluation. That process is known as pre-approval, and helps lenders assess a potential military buyer’s eligibility for the VA home loan program.
Pre-qualification vs. Pre-approval
At the outset, it’s important to know that pre-qualification does not equal pre-approval. Pre-qualification can typically be completed over the phone with a lender, and gives potential borrowers a basic idea of their eligibility and purchase power.
Pre-approval, on the other hand, is a much deeper examination of a borrower’s financial profile. To gain pre-approval, a potential borrower must submit several pieces of documentation, which may include:
- Pay stubs
- Tax returns
- Bank statements
- Evidence of real estate assets
Even more importantly, service members must recognize that pre-approval does not equal a loan guarantee. Although pre-approval is a thorough and extensive process, it’s still only a pre-emptive look at a buyer’s eligibility for a loan. Before a loan can be finalized, the property in question must meet VA appraisal criteria, and the VA borrower is also subject to a final credit check.
Meeting the Service Requirement
The service requirement is often the first determinant of VA loan eligibility. Even those with perfect credit scores and flawless credit reports can’t be eligible for VA financing unless they’ve met one of the following service requirements:
- At least 90 consecutive days of active duty service during wartime
- At least 181 consecutive days of active duty service during peacetime
- At least six years in the National Guard or Reserves
- Some surviving military spouses are also eligible
Service members and veterans don’t need to obtain any “proof of service” documentation prior to speaking with a VA lender. Most VA lenders can access a borrower’s formal “Certificate of Eligibility” (COE) from an automated system within minutes.
Assuming a potential borrower meets the service requirement, lenders move on to the credit portion of the evaluation. The VA does not enforce a FICO score minimum: rather, the agency leaves that decision up to individual lenders. Lender credit guidelines will vary, but a leading VA lender, Veterans United Home Loans, enforces a minimum FICO score of 620.
VA lenders also like to ensure that a borrower’s debt won’t outstrip income. Enter the debt-to-income (DTI) ratio.
A VA lender will tally each of an applicant’s “significant” monthly debts. The DTI evaluation usually only includes debts with an obligation of 10 months or more, such as housing costs, car loans, student loans or child support. But short-term obligations are also sometimes included, particularly if they significantly affect an applicant’s finances.
The sum of those significant debts is divided by total monthly income. The resulting DTI ratio generally needs to equal 41 percent or less to garner VA loan approval. Those with higher DTI ratios can sometimes qualify for financing, but will need to meet additional financial criteria.
Residual Income Requirement
One of the most unique features of the VA loan pre-approval process is the residual income requirement. Designed to protect the financial health of VA borrowers, the residual income requirement ensures veterans have enough monthly cash available after major expenses to cover household needs like food, health care and gasoline.
The VA enforces strict residual income guidelines that vary based on region and family size. For example, a family of five living in the West needs to have $1,158 available monthly after paying the mortgage and other major expenses. Veterans must meet the residual income requirement to gain pre-approval status. Otherwise, applicants can try for a lower loan amount.
Those who fail to meet the DTI ratio of 41 percent must exceed the VA’s residual income requirement by 20 percent. Using the example above, a Western family of five with a 43 percent DTI ratio would need $1,390 in available monthly residual income.
VA lenders love steady employment and consistent paychecks. The ideal VA loan candidate has a minimum of two years of full-time employment with the same employer.
That’s not to say it’s impossible for veterans with less-perfect job histories to obtain VA financing. Underwriters will often evaluate veterans on a case-by-case basis to determine if employment is stable, reliable and expected to continue. Recently discharged veterans or those with part-time or commission-based jobs can certainly earn favor from a VA lender, particularly if they exceed all other preapproval criteria.
Retirees and veterans on disability are also eligible for VA financing. Pensions, retirement income and disability payments are considered “stable” sources of income.
Final Check Prior to Loan Approval
Should a VA loan applicant clear each of these hurdles, preapproval will likely be granted. Keep in mind that all applicants are subject to a final credit check shortly ahead of closing. Any job changes, credit slips or new debt can easily derail a pre-approved buyer. Buyers need to be extremely cautious ahead of final loan approval, and always seek a loan officer’s advice before making big financial changes.
Don’t underestimate the power of pre-approval. Pre-approval gives potential buyers a solid estimate of their VA loan purchasing strength, and helps identify and address any financing roadblocks. Buyers should always pursue pre-approval, and should start the process as early as possible. The early bird gets the “VA financing worm,” and acquires the many unbeatable benefits offered by the VA home loan program.
This guest post was written by Jessi Hall, a former real estate broker and investment property manager. She currently writes about real estate, VA loans and homeownership for Veterans United Home Loans. Follow Jessi on Google+ and the Veterans United Realty blog.