VA Loan Basics
Editor's note: The whiteboard video above reflects earlier VA loan limits. The article below reflects the VA's 2018 loan limits and related VA loan entitlement calculations.
The VA loan program has helped millions of service members, veterans and military families secure home financing since its creation in 1944. This flexible, no-down payment mortgage program was part of the original GI bill signed by President Franklin D. Roosevelt.
Seven decades later, it’s in many ways more important now than ever.
What’s also important is understanding that the government doesn’t make home loans. In the case of VA loans, the Department of Veterans Affairs provides a partial guaranty, basically a form of insurance, for each loan. The government backing on FHA and USDA loans is a little different, but the underlying idea is the same with all three – you’re getting a government-backed loan from a mortgage lender, not a home loan directly from the government.
With VA loans, that government backing gives lenders like Veterans United the confidence to extend financing along with some significant financial benefits, many of which can’t be matched by any other lending option.
Here’s a look at some of the benefits and limitations of VA loans:
No Down Payment
The ability to get into a home without having to make a down payment is the program’s single biggest benefit. This saves veterans from having to stockpile money for years in order to come up with the necessary cash to close on their home loan. The average VA purchase loan is about $240,000. To make a 20 percent down payment, you’re talking about needing nearly $50,000 in cash. Even just a 5 percent down payment – the standard minimum for most conventional loans – would be $12,000.
You’ll often see down payments referenced in terms of loan-to-value (LTV) ratio. This ratio reflects the percentage of the property that’s being financed in relation to its value. A conventional borrower who puts down 5 percent has a 95 percent loan-to-value ratio. Most VA buyers have a 100 percent loan-to-value ratio.
No Mortgage Insurance
VA loans also don’t have any kind of mortgage insurance. Conventional lenders will typically require you to pay for private mortgage insurance (PMI) unless you can make a 20 percent down payment. FHA and USDA loans each have their own forms of mortgage insurance.
With conventional loans, the PMI fee ranges in cost but typically averages between 0.2 percent and 1.5 percent of the outstanding balance of your loan. That fee is added to your monthly mortgage payment by your lender. You’ll usually pay PMI until your loan-to-value ratio reaches about 80 percent.
Let’s assume you’re a conventional borrower with a $200,000 loan. Your lender charges you half a percent of your loan balance for PMI. In the first year, you’ll pay an additional $83.33 monthly in PMI fees. Perhaps $83 may not seem like much of an expense, but that’s roughly $1,000 over the course of a year. Imagine what you could do with that extra $1,000 as a new homeowner.
FHA and USDA loans have both an upfront mortgage insurance fee that’s added to your loan balance and an annual fee that you pay as part of your monthly mortgage payment.
VA loans do come with a mandatory funding fee that goes directly to the VA and helps keep the program running for future generations of military homebuyers. The fee varies by the type of loan, the nature of your service and the number of times you’ve used the program. Most first-time VA buyers pay a funding fee of 2.15 percent. Unlike mortgage insurance, this is a cost that borrowers can finance into the loan. Borrowers with a service-connected disability are exempt from paying the VA Funding Fee.
The VA loan program doesn’t set a minimum credit score requirement. But the VA also doesn’t make loans. So it’s ultimately left to lenders to decide whether to institute a credit score requirement, which most do. VA lenders are typically looking for a credit score around 620, which is traditionally considered just “fair” credit. In contrast, conventional lenders often look for a minimum 660 FICO score, although you’ll often need more like a 740 to have a shot at the best rates and terms.
VA loans also tend to be more lenient when it comes to things like a previous bankruptcy, foreclosure or short sale. The required waiting period following one of these events is usually shorter – sometimes considerably so – than what you would likely encounter with conventional and even FHA financing.
Average interest rates on government-backed loans tend to be lower than conventional mortgage rates. It’s not uncommon for average VA loan rates to fall 0.5 percent to 1 percent below the average conventional loan rate. This lower rate, combined with monthly PMI savings, can substantially lower your monthly payment.
For example, let's take a look at the monthly principal and interest payments on a 30-year, $200,000 mortgage with two different fixed interest rates:
|Monthly Payment at 6.0%:||$1,199|
|Monthly payment at 5.5%:||$1,136|
|The difference each month:||$63|
|The difference each year:||$756|
|Over 10 years, you will have saved:||$7,560|
When compared to an interest rate of 6 percent, a rate of 5.5 percent can save you $7,560 over the first 10 years of your loan. That’s a tremendous difference, and one that buyers should definitely contemplate before choosing a mortgage and a lender.
The VA limits the amount of closing costs that lenders can charge on VA loans. There are also costs that VA borrowers are not allowed to pay themselves. The VA allows the seller to pay all of the buyer’s loan-related closing costs and up to 4 percent of the home’s purchase price in concessions, which can cover things like prepaid taxes and insurance and even paying a buyer’s collections or judgments.
Determining who will pay what in closing costs is part of the negotiation process with a home seller. Talk with your real estate agent about how best to negotiate this in your specific purchase agreement. We cover closing costs later in the course.
VA buyers can use gift funds to make a down payment or cover closing costs. Lenders will want a paper trail coming from an acceptable source, usually a family member or someone with a family-like relationship. No one involved with the transaction can provide gift funds. Buyers will often need to include a gift letter that details the donor’s information, the dollar amount of the gift and the fact that no repayment is expected.
It’s important to understand that these limits don’t dictate how much you can borrow. The VA has county loan limits that help to determine how much you can borrow before needing to factor in a down payment. That’s a big difference. In most parts of the country, qualified buyers with their full VA loan entitlement can borrow up to $453,100 before needing to factor in a down payment. That amount can be higher in more expensive parts of the country. Buyers who want to purchase above their county loan limit will need to put down 25 percent of the difference between the limit and the purchase price.
VA loans are focused on helping veterans and service members purchase primary residences they’ll live in full time. VA buyers typically need to intend to occupy the home within 60 days of closing, although there are some exceptions. You wouldn’t be able to use a VA loan to purchase a vacation home or a purely investment property.
VA loans can be assumable, meaning another person (veteran or not) can essentially take on the terms and payments of your loan. This can be a powerful marketing tool for homeowners if interest rates are on the rise. Lenders and servicers will need to approve most loan assumptions. Some don’t allow them in any case. VA homeowners should understand that a loan assumption could put their VA loan entitlement at risk. To safeguard it, you need a qualified VA borrower to assume the loan and agree to substitute their entitlement for yours. Otherwise, if someone assumes your loan and later defaults, you would lose the VA loan entitlement you used on that property.