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If you’re an eligible active-duty military member, veteran or surviving spouse, you can use a VA home loan — guaranteed by the U.S. Department of Veterans Affairs (VA) — to buy a new property or refinance an existing mortgage. There are benefits of a VA home loan, as well as drawbacks to consider. As you begin the mortgage process, take the time to learn what it means to have a loan guaranteed by the VA.
Pros and cons of a VA loan
Before making a major financial decision, it’s important to weigh the pros and cons of a VA loan. You’ll be taking out a mortgage that you’ll need to pay back over the next three decades, so take time to understand the upfront costs and the entire loan process to determine if this is the right route to take.
Benefits of a VA loan
The benefits of a VA home loan include:
No down payment requirement
While conventional mortgages require a down payment of at least 3 percent of the purchase price, VA loans allow eligible borrowers to become homeowners without putting a penny down upfront. That makes a big difference: Forty percent of Americans who don’t own homes cite an inability to cover a down payment and closing costs as a primary driver for continuing to rent, according to recent Bankrate data.
No mortgage insurance
If you’re comparing VA loans vs. FHA loans and conventional loans, VA-backed loans offer a big point of differentiation: no mortgage insurance. That’s a fee you’ll pay on all FHA loans — both an upfront premium and an annual premium throughout the loan term. You’ll also pay private mortgage insurance (PMI) on a conventional mortgage if your down payment is less than 20 percent.
Lower interest rates
Lenders tend to charge lower rates for VA loans than they do on conventional loans, which means you can save a lot of money on interest in the long run, especially over a 30-year loan.
Lower closing costs
VA home loan closing costs might be less than those for other loans, since the VA limits the origination fee a lender can charge to no more than 1 percent of the mortgage.
The VA doesn’t have a minimum credit score requirement, and some lenders allow for lower scores compared to conventional loans. Additionally, VA loans allow for a higher debt-to-income (DTI) ratio, which can help you qualify for a more expensive or larger home.
No prepayment penalties allowed
You won’t have to pay any extra fees if you want to pay off your mortgage faster or opt to sell your home early. That’s not the case with all conventional mortgages, which can come with prepayment penalties that can drag down your bottom line if you’re working to rid yourself of a mortgage sooner than expected.
Convenient refinancing options
With a VA cash-out refinance option, you can finance up to 90 percent of the value of your home; or you can opt for an Interest Rate Reduction Refinance Loan (IRRRL) that can potentially lower your rate through a streamlined process that doesn’t require an appraisal. Both refinancing options might make a VA loan more appealing overall. Plus, the funding fee on a VA IRRRL is relatively small: just 0.5 percent of the loan amount.
Easier to get back on your feet after a major financial hurdle
If you have encountered a financial challenge — you declared bankruptcy or you sold your home in a short sale, for example — VA loans offer an earlier option to return to homeownership. For example, the typical waiting period after a foreclosure is just two years with a VA loan vs. three years with an FHA loan and up to seven years with a conventional mortgage.
Mortgage is assumable
VA loans are assumable, meaning that a buyer — who, with lender approval, does not need to be a veteran — can take over the terms of the VA loan on the home they’re buying instead of receiving a new loan. VA loan assumptions are especially beneficial when interest rates have been on the rise (which has been the case over the past 18 months), as you could assume a loan with better terms than you could get in the current market. While loan assumptions require extra steps for the seller to keep their full VA loan entitlement after the sale, they can be an excellent perk for a buyer.
Disadvantages of a VA loan
There’s a flip side to every form of financing, including VA loans. The disadvantages include:
Required VA funding fee
While you won’t pay for mortgage insurance with a VA loan, you will pay a funding fee at closing (although this fee can be financed into your loan, increasing the total amount you owe). If you’re taking out your first VA loan and putting down less than 5 percent, the funding fee equates to 2.15 percent of the loan amount. If you do plan to put money down or have obtained a VA loan in the past, the fee can range from 1.25 percent (for first-time or repeat borrowers putting at least 10 percent down) to 3.3 percent (for repeat borrowers with less than 5 percent down).
Not all borrowers are required to pay the funding fee. For example, if you receive compensation for service-connected disabilities or are a veteran’s surviving spouse, you might be exempt from paying the funding fee.
VA loans limit the type of property you can buy (and your purpose for it). First off, manufactured homes are subject to more scrutiny, including a structural engineering examination. Additionally, properties purchased with a VA loan are designed to be owner-occupied, so it’s more challenging to use a VA-backed loan to earn rental income. It is possible, though, if you live in one unit of a multi-unit property and rent out the other units.
With a VA loan, you aren’t allowed to waive certain contingencies, such as the home inspection or appraisal, to make your loan offer more attractive to a seller.
VA loans from the seller’s perspective
If you’re trying to buy a home with a VA loan, it’s important to put yourself in the seller’s shoes to understand how they might perceive your offer compared to other buyers with different types of mortgages. There are some myths about VA loans — that the documentation required can create closing delays or that the appraisal process can derail deals, for example. It can be helpful to work with a real estate agent who knows how to educate the seller’s agent on VA loans, debunk those myths and show that your offer is just as strong — if not stronger — than the competition.
Is a VA loan the best option for you?
For many borrowers, VA loans are a slam dunk. However, even if you’re eligible, there are times when a VA loan might not be your best choice.
“For example, if you are an eligible borrower who currently owns a home but wants to sell and purchase another primary home to yield a large down payment — 20 percent or more — from the sale that you can put toward your next home purchase, a VA loan may not make sense for your next property,” says Rob Killinger, senior loan officer at Movement Mortgage in Massachusetts. “If you were to use a VA loan in this scenario, you may be required to pay the VA funding fee, whereas a conventional loan program would not require such a fee.”
On the other hand, a VA loan offers special benefits that other financing does not. “For instance, a qualified borrower could purchase a two- to four-unit property with a zero down VA loan that they plan to live in instead of a single-family home,” says Killinger. “In comparison, a conventional loan requires a minimum 15 percent down on a multi-unit property.”
Still, the funding fee can be expensive. If you are planning to remain in your home for less than two years, it might not be worth it to pay this fee to get a VA loan.
If you’re still not sure whether a VA loan makes sense for you, consult closely with your loan officer, who can present all of the mortgage options you qualify for and help guide your decision.
Alternatives to a VA loan
A VA loan isn’t your only choice of financing. Consider the following options, especially if you don’t qualify for a VA loan:
- Conventional loan – There is no funding fee on a conventional loan, and you can use it to purchase investment properties and second homes. The interest rates tend to be higher than for VA financing, however, and a down payment is also required, as well as private mortgage insurance if you’re putting down less than 20 percent.
- FHA loan – An FHA loan is also insured by the government and requires you to pay an upfront mortgage insurance premium, similar to the VA loan’s funding fee. However, you’ll also pay an annual mortgage insurance premium. Your interest rate might also be higher.
- USDA loan – As with a VA loan, there is no down payment required for a USDA loan, but it is only for borrowers in designated rural areas. USDA loans also come with income restrictions, and the property must be a single-family home. Plus, only 30-year fixed-rate financing is available.