What is a VA Loan?

A VA Loan is a mortgage loan issued by approved lenders and guaranteed by the U.S. Department of Veterans Affairs (VA). The program was created to benefit active service members currently serving in all branches of the U.S. military, as well as American veterans, reservists and eligible surviving spouses.

The VA does not originate the loans, but it establishes the guidelines to determine who may qualify. In addition, the VA establishes the rules and regulations under which mortgages may be offered, and then it financially guarantees the loans that qualify under the program. VA loans can be used to purchase single-family homes, manufactured homes, multi-unit properties and condominiums.

The United States government created the VA Loan program in 1944 to help returning service members from World War II to purchase homes without the need of a down payment or qualifying credit. To date, this historic program has guaranteed more than 22 million loans, which has allowed active duty military members, veterans, reservists, and their families to purchase homes or to refinance their existing mortgages.

In many respects, the VA Loan program is more important today than ever to military service members. In the wake of the recent housing market collapse, lenders have substantially tightened their lending standards, and often prospective military homebuyers have difficulty meeting those stringent lending requirements. As a result, the VA Loan program is a lifeline to those who are challenged by strict credit and down payment requirements.

The Advantages of a VA Loan

For many veterans, military service members and their families, the VA Loan program is the most advantageous home loan program on the market. These government-backed loans come with numerous benefits that allow homeownership to exist for those who might otherwise struggle to qualify for financing.

The VA Loan program has become increasingly popular, owing to its signature benefits, which include the following:

No Down Payment

Military service members are typically on the move, depending on their deployments, so establishing credit and saving money can often be difficult for them. Recognizing this problem, the VA Loan program allows qualified borrowers to finance 100 percent of the home's value – meaning no down payment is required. This is a substantial benefit for them, given that most lending institutions require down payments of at least 5% of the purchase price for conventional home loans.

No Private Mortgage Insurance

Private mortgage insurance (PMI) is an insurance policy that protects lenders in case of borrower default, and conventional lenders typically require borrowers to pay for PMI, unless they are able to put down at least 20% of a home’s value as a down payment. Again, for many active service members, this is a difficult task to achieve.

However, since the federal government insures all VA Loans and assumes the risk on behalf of the borrower, no PMI is required. This feature is a major benefit to VA Loan borrowers because it allows them to build equity in their homes at an accelerated rate, and it also saves them thousands of dollars over the life of their mortgage.

Competitive Interest Rates

Lenders determine their rates of interest based on the amount of risk inherent in each loan – the higher the risk, the higher the interest rate will be. Because each VA Loan is fully backed by the federal government, lending institutions have less risk, and so they can offer interest rates that are typically lower than conventional rates, usually by at least 0.5 to 1 percent.

Basic Allowance for Housing

Basic Allowance for Housing (BAH) is a housing assistance program that is provided to many active duty military members. The assistance is offered to qualified members so they can provide housing for themselves and their families. However, BAH is only provided to those members who are not currently occupying government quarters or barracks.

BAH is non-taxable money that is paid to recipients on a monthly basis. In terms of the VA Loan program, this is significant because lenders are permitted to treat BAH as effective income to the borrower, which means BAH can be used to pay some or all of a mortgage loan’s monthly costs.

No Pre-Payment Penalty

With many conventional loans, paying off a home loan before it matures results in a pre-payment penalty. The terms of a pre-payment penalty will stipulate what the borrower is allowed to pay off and when. Most conventional mortgage lenders allow borrowers to pay off up to 20% of the loan balance each year.

The justification for a pre-payment penalty is that if a loan is paid off early, lenders miss out on additional opportunities to collect interest payments. A pre-payment penalty is a way for financial institutions to recoup some of that lost money.

This is a significant factor because a pre-payment penalty can be triggered by a variety of circumstances. One way to pay off a loan is if a home is sold, or if the loan is refinanced. In addition, one large lump sum payment might exceed the 20% threshold in a single year as well.

VA Loan borrowers do not have to worry about a pre-payment penalty because they do not exist in a VA loan. As a result, VA Loan borrowers are free to pursue future home purchases and refinancing options as often as they choose with no penalties incurred.

The Different Types of VA Loans

VA Purchase Loans

VA Purchase Loans allow veterans, active duty service members and their families to purchase a home, as long as they meet certain income and credit requirements. As previously mentioned, in most cases, these loans can be obtained with no down payment.

VA Refinance Loans

There are two popular types of VA Refinance Loans – The Cash Out Refinance Loan and the Streamline Refinance Loan.

The VA Cash Out Refinance Loan allows a homeowner to access the equity in their home for cash. There could be numerous reasons why a homeowner might choose to tap into their home equity for cash – paying off high interest debt, making home improvements, paying for a child’s education, etc. Whatever the motivation, a Cash Out Refinance is an effective way to easily access needed cash.

The VA Streamline Refinance Loan is designed to help a homeowner take advantage of those times when mortgage interest rates are low. When interest rates are declining, a homeowner can often lower their monthly payment by refinancing their loan to a lower interest rate. A VA Streamline Refinance Loan (also known as an Interest Rate Reduction Refinance Loan) can help homeowners achieve that goal.

With a VA Streamline Refinance Loan, the interest rate on a loan can be lowered without the expense of any out-of-pocket fees. The lender could either cover the closing costs in exchange for a slightly higher interest rate, or the closing costs can be included in the balance of the loan. Either way, a new loan can be generated without any out-of-pocket expenses to the borrower. Also, generally these loans can be processed quickly and usually require much less paperwork to complete.

However, only those individuals who already have an existing VA loan are eligible for a VA Streamline Refinance Loan.

Native American Direct Loan Program

The Native American Veteran Direct Loan (NADL) program provides eligible Native American veterans and their spouses the opportunity to use their VA Loan benefit on Federal trust land. The VA provides direct home loans (not a loan guarantee) to eligible Native American veterans to finance the purchase, construction, or improvement of homes on Federal Trust Land. The program also offers the opportunity to refinance a prior NADL in order to reduce their interest rate.

Housing Grants for Disabled Vets

The VA provides Grants to Disabled Service members and Veterans to help them construct or purchase an adapted home, or to modify an existing home to accommodate a disability. There are two grant programs that exist to facilitate the grants – the Specially Adapted Housing (SAH) grant and the Special Housing Adaptation (SHA) grant.

SAH Grants help Veterans with certain service-related disabilities to live independently in a barrier-free environment. SHA Grants help Veterans with certain service-related disabilities adapt or purchase a home to accommodate the disability.

VA Land, Construction, and Home Improvement Loans

If you’re a qualifying veteran, you can do a lot more with your VA loan than you might have thought. There’s the option for a land loan, construction loan, and even a home improvement loan.

VA Land Loan

Unfortunately, you cannot buy land without the intention of living on it. That means your dream of living under the stars is out of the picture—unless you’re planning to sleep on your front porch. This is because the VA requires that you not only be able to live on the land but function on it as well. You can get as much property as your heart desires—so long as you can afford it—but you also have to have a house on it, and it must be your primary residence.

The VA won’t support your loan if you cannot immediately—waivers are available if you need more time—move into a safe and sanitary dwelling upon purchase. You’ll need running water, electricity, safe conditions, and that means everything has to be up to code.

VA Construction Loan

Let’s say you already have land—that did not involve a VA loan—you could use the VA to place a modular or pre-fabricated home onto your property. You also have the option of building your house on that land. Just because you didn’t utilize the VA loan to get started doesn’t mean you can’t use it in the future, so long as the property is safe, and by the time it’s done, both livable and up to code.

VA Home Improvement Loan

A VA Home Improvement Loan is basically what it sounds like; you have a home, it needs improvements, and you need a loan to finance it all. However, it’s not nearly as easy as it sounds, and there are several qualification factors you need to consider first. Unfortunately, a VA Home Improvement Loan does not come without a VA Home Loan. So, if you want to make improvements, you must be purchasing your home through the VA and have your lender combine all the costs, including repairs.

If you’re planning to purchase a loan for repairs or alterations to your home, you should plan on the possibility of paying up to 2% in construction fees.

VA Loan Fees and Regulations

Though a down payment is not required on VA loans, a military service member or veteran is responsible for paying the loan’s closing costs. Generally speaking, VA Loan closing costs average around 1% – 3% of the loan amount on more expensive homes, and typically average 3% – 5% of the loan amount on less expensive homes.

However, an exception to this rule is that a home’s seller is permitted to pay all of the veteran’s closing costs, up to 4% of the home price. So, it is possible for the service member or veteran to close their home purchase loan without any out-of-pocket expenses.

VA Loan Closing Costs

First, it is important to note that the types of fees usually associated with a VA Loan closing vary greatly by geographic location. In order to know precisely what kinds of fees and costs are applicable to your specific loan, it is best to consult with your loan professional.

VA Upfront Funding Fee

The VA Upfront Funding Fee is a fee applied to every purchase or refinance loan. The fee goes directly to the Veterans Administration and helps to defray the costs of the VA Loan program.

The amount of the fee varies depending on several factors – the circumstances of the borrower’s service; whether the borrower has been a recipient of a previous VA loan; and if the borrower has a down payment. Veterans who receive disability compensation for a service-related disability – including those who are eligible to receive disability compensation – are exempt from paying the funding fee.

In general, this upfront funding fee is not paid in cash at the closing, because VA home buyers usually choose to include it in their loan amount.

1% Origination Fee

This fee is paid to the lender as compensation for originating the loan. The VA stipulates that the lender’s compensation cannot exceed 1% of the loan amount. If the lender charges the 1% origination fee, then they are not allowed to charge for other additional fees, such as processing and underwriting services.

Discount Points

Discount points are, in fact, prepaid interest on a home mortgage loan. A borrower can “pay for” discount points as a way to lower the interest rate on their loan. The more points you pay, the lower the interest rate on the loan. Typically, borrowers pay 0–4 points, and this kind of discount point is tax-deductible.

Military service members and veterans can pay for discount points as long as the fee goes directly to reducing the interest rate.

Third Party Fees

In the closing of any loan, there are usually third party companies involved in the transaction. These are companies that provide necessary services in order to close the loan. Below are examples of the kinds of third party companies one can expect to be involved at a VA Loan closing:

• VA Appraiser
• Title Report/Title Insurance Policy
• Recording Fee
• Credit Report Fee
• Flood Certification Fee
• Survey Fee
• Attorney Fees

VA Tidewater Initiative

Evoking Tidewater is not code for your house getting swallowed up by the sea. In fact the sea has nothing to do with it. When the VA invokes the term tidewater it means their appraiser said the house isn’t worth the offer you presented to the seller. For example, let us say Mr. Jones is selling his home for $220,000 - you offer $200,000 and get the house appraised—through a VA approved appraiser of course—and he or she comes back and says, you shouldn’t be offering no more than $190,000.

He’ll send this report to your lender and you don’t get the house. Okay, not really (not immediately, anyway). What actually happens is your lender gets the notice and then the lender gives it to the relator. The lender then has 2 days to get this information from the realtor to the appraiser, proving that the house they’re selling you is worth the amount they claim or agree to let you purchase the home for- this is done by showing comparable sales in the area.

So while it has nothing to do with a physical sea swallowing up your future home, it has everything to do with your appraiser’s opinion (based on comparable sales) swallowing up your dreams as a new homeowner. If the disagreement can’t be fixed your options are to not use a VA loan—if possible—or walk away from the house and find another dream home.

Eligibility Requirements For VA Loans

Who is Eligible?

Veterans, active duty service members, National Guard members and reservists are all eligible for a VA Loan if they meet the basic service requirements, as defined by the Department of Veterans Affairs.

Ultimately, the VA will determine who is eligible, but their basic eligibility guidelines are listed below. Borrowers may be eligible for a VA Loan if they meet one or more of the following conditions:

• They have served 90 consecutive days of active service during wartime
• They have served 181 days of active service during peacetime
• They have more than 6 years of service in the National Guard or Reserves
• Spouses of military members who died while on active duty or as a result of a service-related disability may also be eligible

In addition, a borrower must also have proof of sufficient income, satisfactory credit, and a valid Certificate of Eligibility (COE) to be eligible for a VA-guaranteed home loan. Also, the home must be for the borrower’s personal occupancy.

VA home loans may be used to:

• Buy a home
• Build a home
• Buy a condominium unit in a VA-approved project
• Buy a manufactured home and lot
• Buy and improve a home simultaneously
• Improve a home by installing energy-related features or making energy efficient improvements
• Refinance an existing VA-guaranteed or direct loan in order to obtain a lower interest rate

What is a Certificate of Eligibility?

Lenders that issue VA-guaranteed loans are required to validate a veteran’s service record during the VA loan process. The Certificate of Eligibility (COE) serves as that proof, and it verifies that an applicant has officially met the minimum service requirement.

All veterans have to meet one or more of the following service requirements in order to qualify for a VA loan:

• 181 days of service during peacetime
• 90 days of service during war time
• 6 years of service in the Reserves or National Guard
• Some surviving spouses of service members who have died in the line of duty are also eligible

How to Apply for a Certificate of Eligibility

There are three primary ways eligible VA Loan borrowers can apply for a Certificate of Eligibility:

1. Ask your lender - The easiest and most direct method of obtaining a Certificate of Eligibility is to ask your lender. VA- approved lenders have access to a special database and they can obtain your COE in minutes.
2. Apply online - Go online to the eBenefits website (a service provided by the Department of Veteran Affairs and the Department of Defense) and log in or create a new account.
3. Apply via mail - Print this form, fill it out, and return it to the address on the form.