What Exactly is the VA Loan?
The VA Loan is a mortgage that helps veterans finance the purchase of homes with good loan terms and interest rates that are typically better than what you would see on other types of mortgages.
VA home loans aren’t made by the VA itself, but by private lenders such as banks, savings and loans associations, and mortgage companies. VA guarantees the loan if and when the applicant is approved.
People often say the VA guarantees loans, but that’s not accurate. Actually, the VA typically guarantees 25% of the loan. This still gives lenders a lot more comfort in lending, because if you stop paying, there is a higher chance they won’t lose any money on the deal.
What’s the Most I Can Borrow?
The way VA loan entitlement amounts are tracked is strange to say the least.
I think government entities love doing things in a way that’s not straight-forward. I’ll explain.
Everybody who qualifies for a VA loan starts off with a full entitlement.
You can be sure you have a full entitlement by viewing your certificate of eligibility, or COE. It’s a document you get from the VA.
If your COE say that your entitlement is $36,000, then you have a full entitlement.
This number is $36k because the VA previously used $144,000 as a baseline for tracking entitlements. 25% of $144,000 is $36,000, which is a full entitlement.
This means the VA will guarantee 25% of a $144,000 loan. This allows VA loan lenders to offer you no money down.
Under new rules which went into effect January 1 of 2020, borrowers with a full entitlement (which is $36,000) don’t have a limit on how much they can borrow with no down payment.
The previous limit of $144,000 doesn’t mean anything now. It’s a leftover number from old rules.
So no limit on the loan amount, but you have to qualify for the loan under your lenders credit and income rules.
The VA does not limit the loan amount that can be guaranteed, but your lender will still want you to prove you make enough for this additional loan.
There are two ways to have a full entitlement.
- Haven’t used your VA loan entitlement yet – or –
- You used it, repaid it, and now have the original VA loan entitlement amount reinstated.
Getting Additional VA Loans
You may be able to get additional VA loans, even if you still have VA loans that you owe money on.
You just need a valid reason to move. It can be PCS for your job, retirement, upsizing, or downsizing. Talk to a VA lender to confirm your reason is ok. The property that you move out of can become a rental property.
Your new VA loan will be guaranteed up to the conforming loan limit in the location you want to buy minus the loan amount you’ve already got.
The standard 2022 VA Loan limit for a single family property is $647,200. It’s higher in expensive cities, and even higher if you buy a multi-family property.
This limit means if you default on your loan, the VA will pay your lender up to 25% of the county loan limit minus the loan amount you have already used.
This means it is possible that you could have no money down, but if you don’t have enough entitlement remaining, you may be required to contribute a certain amount towards the downpayment.
Calculate Remaining VA Loan Entitlement
Let’s use my situation to calculate how much more money I can borrow no money down from the VA. I’m going to adjust my numbers a little to make the math easier to follow.
I own one property with a VA loan. It is my current primary residence. The loan amount is seen on my certificate of eligibility (COE) and is $400,000.
I want to buy another property in Montgomery, Alabama. The loan limit in this city in 2022 is $650,000.
$650,000 – New loan limit minus $400,000 – Prior loan amount
equals $250,000 remaining borrowing power.
This is the amount I can borrow without needing a downpayment.
What if I wanted to buy a house that cost more than that?
For VA loans, the lender wants a 25% downpayment for the amount of the loan exceeding the loan limit.
We’ve determined that I have $250,000 remaining in borrowing power by subtracting my prior loan amount from the loan limit.
$650,000 – $400,000 = $250,000
For every dollar over $250,000, I need to contribute 25 cents (25%) as a downpayment.
If I want a loan for $350,000, but I only have $250,000 left in no-money-down borrowing power, then I’m $100,000 over the loan limit.
I don’t need to come up with the entire $100k. I need to come up with 25% of that.
$100,000 X .25 = $25,000
So on a $350,000 loan, my downpayment is only $25,000, because the VA is still guaranteeing $250k (my remaining entitlement), and I’m only making a downpayment on the remaining $100k.
I have no idea if I did a good job explaining that.
Call your lender with you certificate of eligibility in hand, and they can walk you through the calculation.
Who Can Get a VA Loan?
VA loans are open to veterans, active duty service members, National Guard members, and reservists. You just need to meet certain requirements set by the Department of Veteran Affairs.
You need to meet one or more of the following conditions:
- Served at least 90 consecutive days during wartime
- 181 days of active service during peacetime
- More than 6 years of service in the National Guard or Reserves
- The spouse of a service member who has died in the line of duty or as a result of a service-related disability
How to Apply for a Certificate of Eligibility
The above guidelines will give you a good idea if you are eligible or not.
It’s up to the VA to determine who is eligible for a VA loan. This is done through applying for a certificate of eligibility (COE).
VA lenders will want to see this document before you can get your loan. There are three different ways to get this COE.
- Online using the VA eBenefits portal
- Through a VA-approved lender
- By mail wit VA Form 26-1880
Who can qualify for a VA Loan?
What is the minimum score for a VA home loan? We just need to ask the VA, right?
That’s not how this works. The Department of Veterans Affairs oversees the loan program and guarantees a portion of each loan in case of default.
The VA, however, does not issue loans.
The VA also does not enforce credit score or income requirements.
Those will vary depending on each lender. In the case of credit scores, several prominent lenders want a minimum of 620, which is on the low side.
In April of 2016, the national average FICO score was 699. Conventional loans usually want 740 or better.
The VA can sometimes go lower than 620, maybe as low at 500 in certain cases, but the interest rate will be higher.
Lenders don’t typically have an income threshold, but want to see stable income. They want to ensure after all bills are paid there is a sufficient amount of money left over each month to cover a family’s expenses.
Obviously, this is not very concrete, so you’ll need to speak to your lender about your income and what you’ll be able to borrow.
Pros and Cons of the VA Home Loan Benefit
Pro: No Private Mortgage Insurance
If you get a conventional loan and have less than 20% down, and certainly no money down, you will be required to pay private mortgage insurance (PMI). This protects lenders in case of default.
With a VA loan, there is no PMI. This is possible because of the funding fee (which can be rolled into the loan) and the VA’s guarantee on the loan.
Pro: Low Interest Rates
One of the factors in the interest rate is the amount of risk to the bank. Since the VA is guaranteeing a portion of the loan, this allows the lender to give a more competitive rate than would otherwise be possible with no money down.
Pro: No Money Down!
This is a big one.
The ability to buy a house with no money down can be a huge blessing to a family looking to purchase a property. This is especially true for those families that just haven’t saved up a down payment yet.
This can get very interesting because you can also put no money down on a 2, 3 or even 4 unit property.
This would allow you to live in one unit, and rent out the others, allowing you to subsidize a portion of the mortgage with renters. This is often called “househacking” and can become a very good investment under the right circumstances.
Pro: No Pre-Payment Penalty
Certain types of loans have pre-payment penalties. This is because lenders miss out on the ability to collect interest payments if loans are paid back too quickly. Rest easy. VA loans never have this type of penalty.
Con: The Funding Fee
Ok, so no private mortgage insurance doesn’t necessarily mean no additional fees associated with a VA Loan.
In a sense, this is sort of a substitute for PMI. It kind of negates calling no PMI a Pro.
VA loans have a funding fee as part of closing costs. It means, in most cases, you will pay at least 2.3% of the loan as a fee at closing. This can end up being pretty significant.
You do have the option of rolling this fee in to the loan, which helps with upfront costs.
If you have a disability rating, the funding fee is waived.
Click here for funding fee info from the va.gov website.
Con: The VA Appraisal
Properties that will have VA loans must have a VA appraisal. This is a completely separate issue from getting a home inspection, and you’ll still want to get a home inspection in addition to the VA appraisal that is mandatory.
The purpose of the VA appraisal is to determine if the property is safe, sound, and sanitary according to VA standards.
VA appraisals make it difficult or impossible to buy fixer-uppers, or properties that need a significant amount of work. This can be a problem, as buying distressed properties is a great way to get a great deal and add value when you buy a property.
The VA Loan Process
The steps are:
- Finding a Property
- Putting the Property Under Contract
Getting preapproved is not a must, but it’s helpful for many reasons.
For one, you’ll have a better idea upfront if they’ll be any problems getting a loan and how much money you’ll be able to qualify for.
Next, you’ll get a letter through the preapproval process that many seller want to see before they will take your offer seriously. This will help you get under contract, especially in a competitive market with multiple offers.
The lender will need a bunch of information from you about your employment and income and run a credit check as well. A 620 credit score is a common minimum for VA loans.
You may be asked to provide documents to verify aspects of your income and employment. (Yes, some people lie about this stuff)
Common documents they ask for are recent W-2s, driver’s license, bank statements, and disability award letters.
Finding a Property
With your preapproval letter in hand, you are better equipped to find a property and deal with real estate agents.
I will say working with real estate agents is worth it. Yes, they get a commission. As long as you ensure they are doing a good job and providing the service you expect, the commission is worth it.
You want real estate agents who have track records of selling lots of homes. Try to get referrals from friends. Thoroughly vet them on the internet, and ensure they appear professional. If at any time they are not being responsive to your needs or expectations, you tell them.
Don’t be shy! There’s a lot of money at stake!
I’ve fired real estate agents and picked new ones when I felt like they weren’t doing a good job.
VA loans need to be used to purchase a house you intend to live in. You can purchase up to a 4-unit property, and rent out the extra units, as long as you intend to live in one of the units.
Curious how to invest with the VA loan? Read my:
As I talked about earlier, the home will need to undergo a VA appraisal. This means the house needs to be in pretty good shape. It can’t be something that needs extensive work.
If defects are noted, they’ll need to be addressed before closing. Either you or the seller can fix them. That’s something you negotiate. As I alluded to earlier, these appraisal can cause problems in properties that need significant work.
You can use your VA loan to purchase:
- Single family homes
- Multifamily up to 4 units
- New Constructions
- Manufactured and modular housing
Putting the Property Under Contract
Be sure to talk with the loan officer about closing costs before you go under contract. Buyers are able to ask the seller to pay all closing costs up and to 4% of the loan in concessions.
2022 Market note: It is uncommon for sellers to pay closing costs in this hot sellers market.
The contract that you present to the seller should have several contingencies in it set up to protect you, such as a financing and inspection contingencies, and what the deposit will be and under what circumstances it can be returned.
While the VA does require their appraisal, that is not the same as getting a home inspection.
Remember, the appraisal is for them. Getting a home inspection is for you. I recommend you get one where all deficiencies are noted and you can decide if you need to discount the property or get certain things fixed before closing based on those findings. This is a great negotiation technique. Well worth the money.
You always want a contingency to get your money back should the VA appraisal come in with an appraised value too low. This may mean they would ask for an additional down payment. In this case, you could choose to walk away from the deal and get your earnest money (deposit) back.
Once the property is under contract, this is where things start to happen. The appraisal gets ordered and occurs, and all the paperwork gets processed and scrutinized.
The VA will assign someone to perform the appraisal, it’s not something the lender or you have any control over. They will make an appraisal based on comparable sales and the condition of the property.
The appraiser will check to see if the home is safe, sound, and sanitary according to VA standards.
The graphic above was created by Veterans First Mortgage to give an idea of the items the appraisal will focus on to determine the property is safe.
While this appraisal process is going on, the loan officer will be peppering you with questions about your employment, work history, credit, etc. Be sure to answer these issues quickly so the underwriting process doesn’t slow down.
Once the appraisal is good and the underwriters have no more questions and are comfortable, you are “clear to close”. This means a closing date can be set.
You should receive documents before closing estimating what the costs will be. I’ve seen them referred to as closing disclosures or HUD-1 estimates. Look over them carefully and question anything that doesn’t make sense to you.
It’s a good idea not to do major things that affect your financial situation while the loan is in underwriting. Examples of this would be opening new credit cards or lines of credit, moving large amounts of money around, buying an investment property, etc.
This will just slow things down and scare everybody!
Do a last walk through before closing and make sure everything is to your expectations, or don’t close!
A note about closings. I’ve closed on many a home in my life. I think going to closings is awkward and a waste of my time. I don’t like sitting in the room with the seller and making small talk about the property.
I haven’t been to a closing in several years. I give my real estate agent power of attorney to sign closing documents on my behalf. It saves me some trouble. You may want to go your first time, but it’s something to consider.
Alternatives to VA Loans
Anyone can qualify for an FHA loan, military member or not.
3.5% is the minimum down payment required, which is pretty good, compared to a conventional loan. You can qualify for this with a credit score of 580, which is also on the low side, so many can qualify. Less than 580, you’ll need 10% down.
You do need to pay a type of private mortgage insurance (PMI). 1.75% is paid upfront, and an annual premium is paid monthly.
Officially known as the Section 502 Single Family Housing Guaranteed Loan Program, this loan is a zero down payment mortgage available in qualified rural or suburban areas. Essentially, it’s not available in big cities, but it is widely available outside of that.
Just check if your area is available.
Don’t bother if it’s NYC, LA, or Honolulu!
Usually they want dependable income over the last two consecutive years, no late payments in the last year, and a credit score over 640. These loans are for low to moderate income homebuyers.
The income limit for USDA home loans is based on your area’s median income. To be eligible for a USDA loan, you can’t exceed the median income by more than 15 percent.
USDA loans also have mortgage insurance, but it’s less than FHA!
Currently, it’s at 1%.
There may be a situation where a conventional loan may be superior to getting a VA loan.
If you want to save money in the long run, and have a 20% down payment, going the conventional route might be the best bet.
By putting 20% down on a conventional loan, you won’t have to pay private mortgage insurance (PMI), and there is no funding fee or other fees. Also, as long as your credit score, income, and debt-to-income ratio are ok, you should get competitive interest rates.
Having trouble saving up a down payment? Read my article on:
Interest Rates with VA Loans
As VA loans are backed by the government, lenders can charge lower interest rates. The VA doesn’t set interest rates. That’s done by each VA lender individually. You’ll want to check with several VA lenders to see what the rates and fees are. Don’t just go with the cheapest rate, go with a company that is established and has a good reputation.
Higher credit scores mean lower rates. This is just common sense, as it’s a question of risk for the lender.
Sometimes you’ll see two numbers quoted with an interest rate. One is the actual interest rate and one is the Annual Percentage Rate (APR). It’s important to know the difference. The interest is just the interest you will pay on the loan.
The APR is typically a higher number because it is the interest plus origination fees, closing agent fees, discount points, and other fees. It’s all rolled up into one number.
Refinancing with a VA Home Loan
There are two options for borrows to refinance. I’ll talk about both options:
If you qualify for a VA loan, you can refinance your loan at a lower rate, and pull out the equity as cash if you would like to.
This is not the same as a home equity loan. That is a separate loan that exists in addition to your current mortgage. A refinance is a new loan that completely replaces the old loan.
You are not required to pull cash out in this refinance. You could simply refinance at a lower rate without taking out additional money. It’s up to you.
The process for getting the refinance is almost identical to getting the VA loan in the first place as far as eligibility, credit, closing costs, etc. The VA funding fee is higher for a cash-out refinance. Ouch!
You can still roll the funding fee into the loan.
Homeowners in Texas may encounter restrictions on cash out refinances.
Closing costs cannot be rolled into the loan and must be paid at closing. That can be 3 to 4% of the loan amount. Yowzer!
The Streamline Refinance a.k.a. Interest Rate Reduction Refinance Loan
This is a great loan if you already have a VA loan and want to lower your monthly payment through a refinance.
These can be completely quickly because there is no required appraisal and, in some cases, no need to get a certificate of eligibility (COE). Also, there are minimal out of pocket costs.
This loan is not available to someone with a loan other than a VA loan.
You usually cannot get this loan unless it will result in a lower monthly payment or shorter term.
There is not a occupancy requirement on this home. If you have already moved away and have renters in the property, you can still get this loan.
You cannot extract equity, or pull cash out of this refinance. That is what the VA cash-out refinance is for, and it’s a more expensive product.
The VA funding fee is only .5% on this refinance. That’s low! You can roll it into the new loan.
Assuming a VA Loan
Something unusual about VA loans is that, depending on the lender, they can be assumable. Not every lender participates, you need to check with the one you’re working with.
Assuming a loan means that you can have someone take over your mortgage and your interest in the property. This means they would assume your interest rate, mortgage payment, and loan balance.
There are two things you have to make sure that happen for sure if you use this option. You need to obtain a release of liability from the loan. Otherwise, your credit could still be penalized if the new owner made late payments or defaulted.
Second, you need to make sure the person assuming the loan can give you their VA loan entitlement. If not, the entitlement will stay with the loan until it’s paid off. That will prevent you from using the entitlement for the foreseeable future.
This can be an attractive option in a market where interest rates are rising. If you locked in a low rate, and are selling when rates are higher, the assumption of your loan could be very attractive. It’s something to think about!
I currently own 30 properties, 20 of them free and clear. I’ve done this all part-time while overseas in the military. Find out how I do real estate. Read the
Rich on Money’s Complete Guide to Real Estate Investing
Good luck out there!
Rich on Money