Second, the value of income will change, depending on where you live. This very much impacts the concept of qualifying borrowers on the basis of gross income. Prior to tax reform, such things as mortgage interest, property taxes, and state income taxes were com- monly deductable, but now — with a larger standard deduction — the value of itemizing for most borrow- ers has fallen to zero. Imagine that two married couples each have a gross annual income of $120,000. They're alike in every way except for where they live. Living in Los Angeles, the couple will pay $8,004 in California state income taxes whereas in Florida, Texas, Wyoming, Washington, South Dakota, Nevada, and Alaska, the tax bill is zero. There is no state income tax in these jurisdictions. The couple in the no-tax states has an additional after-tax, income. Why is that money – which is both real and spendable – not used to gross up the income for borrowers in Florida,

Texas, etc? How is it any different from child support or business de- preciation? There is, in fact, a way to capture the blessings of lower tax costs. The Department of Veterans Affairs (VA) requires lenders to look at residual income (the cash left over after ex- penses) when qualifying borrowers. "The VA’s residual income guide- line offers a powerful and realistic way to look at affordability and whether new homeowners have enough income to cover living expenses and stay current on their mortgage," says Chris Birk with Veterans United. "Residual income is a major reason why VA loans have such a low foreclosure rate, despite the fact that about 9 in 10 people purchase without a down payment.” “In the end,” says Carrington’s Ray Brousseau, “residual income is critical. It’s what’s left that the family is expected to be able to live on. Residual income is an important characteristic when measuring abili- ty to repay.”

The VA approach works extremely well. In the fourth quarter, ac- cording to the Mortgage Bankers Association (MBA), the non-season- ally-adjusted foreclosure starts rate stood at .19 percent for conventional loans with either 20 percent down or backing with private mortgage insurance, .55 percent for FHA- backed financing with as little as 3.5 percent down, and .28 percent for VA loans which are readily available with zero percent down. We’re going to see the wider use of residual income. But that does not mean the gross income stan- dard will melt away. Instead, it will increasingly make sense to reduce origination risk and qualify appli- cants on the basis of both gross income and residual income.


A key measure of borrower financ- es is very simply the fact that they have a job. Lenders generally like

18 | think realty housing news report :: june / july 2019

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