VA loans are made by approved lenders, but are guaranteed by the federal Department of Veterans Affairs. This guarantee is similar to mortgage insurance in that it protects the lender against loss in the event of the borrower’s default. The veteran borrower is charged a non-refundable upfront funding fee, which can be financed, instead of a mortgage insurance premium, for the guarantee.
A veteran receiving VA compensation for a service-connected disability is exempt from the fee requirement. The fee varies based on whether the borrower is a first-time VA borrower or a repeat borrower, whether he is eligible due to service in the regular military or the reserves or National Guard, and whether he puts nothing down or at least 5% down. The fee for a first-time VA borrower who is a veteran of the regular military is 2.15% of the loan amount. It is higher if he qualifies as a reservist or has obtained a VA loan previously. It is lower if he makes at least a 5% down payment. As with the FHA premium, this fee can be financed in the loan.
The primary advantage of a VA loan is that there is no down payment required on a loan of up to the Freddie Mac conforming loan limit. In addition, the seller can pay:
- all of the borrower’s nonrecurring closing costs and discount points, with no limit.
- up to 4% of the sales price in seller concessions. Concessions include prepaid taxes and insurance, the VA funding fee, payoff of the borrower’s existing debts, temporary buy down fees, and gifts.
It is easier to qualify for a VA loan than for a conventional loan. The VA uses two methods for qualifying borrowers:
1. A 41% debt-to-income ratio (including housing and fixed debt).
2. The residual income method, which determines whether the veteran has enough income after paying his fixed debts to cover his daily living expense. It can qualify a borrower whose ratio might exceed the 41% limit.
A VA loan is available only to veterans of the armed services, those currently on active duty, and their spouses; however, the loan is assumable by nonveterans.
In order to obtain the loan, the applicant must obtain a Certificate of Eligibility from the VA. This will determine whether he is eligible for a VA loan and whether he is eligible for a loan with the full guarantee.
The maximum loan guarantee varies depending on the location of the property. While the VA does not have a maximum loan amount, it will guarantee to the lender the lesser of 25% of the loan balance or of the Freddie Mac limit. For high-cost counties, the guarantee is the lesser of 25% of the loan balance or of the VA county loan limit, which takes into consideration the county’s median home price and the Freddie Mac conforming loan limit. The guarantee enables the lender to avoid losing money if he could recoup 75% of the loan balance from a sale of the borrower’s property at or after foreclosure.
An applicant who has used all or part of his entitlement for a VA loan can get it back to purchase another home if any of the following applies:
- The prior property has been sold and the VA loan has been paid in full
- A qualified veteran buyer has agreed to assume the outstanding balance on the VA loan and substitute his entitlement for the same amount of entitlement the applicant originally used to get the loan
- One time only, the applicant has repaid the prior VA loan in full, but has not disposed of the property securing that loan
- Even if an existing VA loan has not been paid off, the applicant has “remaining entitlement” due to an increase in the maximum entitlement amount since he obtained that loan
The borrower must also sign a Certificate of Occupancy, certifying that he will use the property as his primary residence. As with an FHA loan, for a VA loan the applicant must intend to move in within 60 days after closing and stay in the property for 12 months.
A veteran cannot borrow more than the value shown on the VA appraisal, called a Certificate of Reasonable Value (CRV). He can, however, buy the property for a higher purchase price if he pays the difference in cash. If he does not wish to do so, he can terminate the transaction and receive a refund of his earnest money, utilizing an escape clause required in the VA sales agreement.
The VA does not warrant the condition of the property and is not concerned with cosmetic items, such as chipped paint. However, if the property was constructed before 1978, any area with chipping or peeling paint must be stabilized (i.e., scraped and painted to remove the lead-based paint hazard) and a lead paint notification and disclosure must be provided to the buyer.