There was a time when Veterans Administration (VA) loans were so time-consuming to obtain that lenders did not want to process them and home sellers were likely to reject offers from buyers planning to finance with VA loans. Thanks to changes in the system, it has become much easier to take advantage of the unique benefits offered by VA loans.
VA loans are offered through the Veterans Administration, a U.S. government organization that provides benefits and services to eligible veterans, active duty, reservists and National Guard members along with their families. While the VA does encourage lenders to offer these loans by guaranteeing to repay a significant percentage of any loan that goes into default, VA loans are actually made by private lenders, not by the VA itself. This means that the lender, not the VA, determines whether a borrower is eligible for a loan and what loan terms the borrower qualifies for. As such, it’s still important to shop around for the best deal on a VA mortgage.
Unique Characteristics: No Down Payment, No PMI
A few years ago, lots of lenders were offering 0%-down loans. After the housing market crashed, that option disappeared. The VA loan program, however, still offers the option to buy a home with no down payment. Not having to make a down payment will help you maintain your emergency fund, which is crucial when you’re a homeowner. And if you already have plenty of money in your emergency fund, not having to make a down payment might allow you to make repairs or renovations that you couldn’t otherwise afford.
Unique Benefits Bring Unique Disadvantages
Unfortunately, VA loans aren’t available to everyone. They’re limited to eligible veterans, active duty, reservists and National Guard members, and some surviving spouses, all of whom must prove that they’re qualified by obtaining a certificate of eligibility from the VA (the lender can often complete this step for the borrower). You can learn more about who is eligible at the United States Department of Veterans Affairs website.
VA loans are only allowed for owner-occupied primary residences, so don’t plan to use one if you’re looking to finance an investment or vacation property. Also, lenders won’t finance VA construction loans according to the book Your Guide to VA Loans by David Reed.
Perhaps the biggest disadvantage of a VA loan for those who are eligible is that it requires a funding fee. For homebuyers taking out a VA loan for the first time and not making a down payment, the funding fee is 2.15% of the loan amount for regular military veterans, and 2.4% for members of the reserves or National Guard. If it’s not your first time using your VA entitlement, the funding fee jumps to 3.3%. Since this cost is a fee, it doesn’t contribute to your home equity. It is essentially a closing cost. The VA uses these funding fees to help pay the guarantees on VA loans that go bad.
Few people will be exempt from the funding fee. Borrowers who don’t want to pay for it can try asking the seller to pay it, just like they might ask the seller to pay any other closing cost. It’s also possible to roll the funding fee into the loan, which is a good short-term solution for cash-strapped buyers but a bad long-term solution because then the borrower must pay interest on the funding fee for the life of the loan.
VA Vs. FHA Vs. Conventional
Because they are the two lowest down-payment options available, many borrowers who are eligible for VA loans might also be considering FHA loans – a loan insured by the Federal Housing Administration. If you qualify for both, which one should you choose and why?
FHA mortgages require a fee similar to the VA loan’s funding fee. It’s called up-front mortgage insurance and it costs 2.25% of the loan amount as of May 2010. FHA mortgages also require borrowers to pay monthly private mortgage insurance at a rate of about 0.5% annually of the loan amount until the borrower accumulates 22% equity.
On a $200,000 house, then, an FHA loan would require you to put down $7,000, pay a fee of $4,243.50 (0.0225 x $193,000), and pay an additional $965 (.005 x $193,000) a year for PMI. If you rolled that funding fee into your loan, your monthly mortgage payment and PMI would go up slightly.
A VA loan, on the other hand, would require $0 down, a fee of $4,300 to $4,800, and no PMI. If the interest rate on your mortgage was 6% and your term was 30 years, your monthly principal and interest on the FHA loan of $193,000 would be $1,157.13; on the VA loan of $200,000, it would be $1,199.10, a difference of $41.97 a month or $503.64 a year.
If you have a significant down payment, your best option might be a conventional mortgage. You’ll avoid the funding fee of 1.25% to 1.5% that the VA charges even when borrowers have a down payment of 10% or more. On a $200,000 home with a 10% down payment, the VA’s funding fee would be $2,250 or $2,700 (.0125 x $180,000 or .015 x $180,000).
Despite the funding fee, the lack of a down payment requirement and PMI make VA loans a very attractive option for qualified homebuyers.