How Does a VA Loan Work?
When it comes to home loans in the United States, the means and methods run the gamut. And the criteria and characteristics of each type of loan–not to mention the jargon involved–can be confusing.
Veterans Affairs loans, however, are rising in popularity among veterans who are looking for a flexible lending option that doesn’t require a down payment.
Although the eligibility details for VA loans can get pretty involved, millions of active military, veterans and surviving spouses are eligible to participate in the program. You’re likely in the mix if you meet one of the following conditions:
- You served 181 days on active duty during peacetime;
- You served 90 days on active duty during wartime;
- You served six years in the Reserves or National Guard; or
- Your spouse died in the line of duty or from a service-connected disability.
It’s important to remember that being eligible for a VA loan doesn’t mean you’re guaranteed one. Military borrowers will have to meet both VA and lender requirements, covering everything from the borrower’s credit and debt-to-income ratio to the property’s condition and market value.
How to Secure a VA Loan
The VA doesn’t actually issue loans. Rather, it basically insures a portion of them, and that fiscal guaranty gives lenders the confidence to extend no-down-payment financing with competitive rates and terms.
Lenders in the current climate are looking for a credit score of at least 620, far below what conventional lenders require. The VA wants homebuyers with a debt-to-income ratio of 41% or less. Those with ratios above that benchmark aren’t automatically excluded, but they have to clear additional financial hurdles.
The VA also uses a unique financing requirement called residual income, which is essentially how much money you have remaining each month after major expenses. Borrowers have to meet residual income benchmarks that vary by geographical location and family size.
Borrowers can choose to put money down, but they aren’t required to unless they’re seeking a loan greater than the VA’s county loan limit, which is $424,100 in most parts of the country.
When Would You Use a VA Loan?
You can use a VA loan to buy a new residence, to refinance an existing mortgage to lower the current interest rate or to refinance to take out cash. You can also use the money to buy a farm residence, as long as that farm isn’t used to produce income. While the loan does have some restrictions on buying land and investment properties, the large majority of options remain open for veterans looking for a flexible home loan.
Roughly 90% of VA loans are issued without a down payment. They have lower interest rates than most home loans, and that’s one of the reasons why VA loan volume is increasing by more than 80% annually. These loans also have a good track record: The delinquency rate for VA loans is less than FHA and subprime loans, and the foreclosure rate is a mere 2.5%–outperforming subprime, FHA and prime loans by a wide margin.
To be sure, VA loans aren’t a great fit for every veteran borrower. Those with sterling credit and enough liquidity to cover a solid down payment may be able to save money by seeking conventional financing. The VA charges a funding fee on every loan it guarantees. A percentage of the loan amount, this fee helps keep the loan program going.
While VA loans are only a small part of the mortgage market, veterans are seeing that the benefits of the program outweigh the restrictions, and loan volumes are growing faster than ever before.
What Other Benefits Do VA Loans Offer?
In addition to the unique no-down-payment policy, VA loans do not require borrowers to hold monthly private mortgage insurance. That means more money in your pocket that would otherwise go to an insurance company, and it signals an extension of trust from the VA to the veteran it is serving. The VA promises to repay the lender a portion of the loan if the borrower defaults.
The flexible credit and underwriting guidelines also make VA loans an attractive and reasonable way for a veteran to get the money s/he needs to pay for a home.
There are no pre-payment penalties, so it’s fine to pay off a loan early. These loans are also assumable, which means a non-veteran can take over the mortgage if you decide to unload the property.
For more than 70 years, this loan program has become more and more important for active military members, veterans and their families. Lenders have tightened credit and underwriting requirements in the wake of the subprime mortgage meltdown. Interest rates are hovering at record lows, but it’s difficult for many borrowers to secure home financing without great credit and a sizable down payment.
That’s why military borrowers continue to flock to the VA program. Decades later, this long-cherished program continues to open the doors of homeownership to those who serve our country. It may be able to do the same for you.
Chris Birk is a former journalist and director of education for Veterans United Home Loans.