Are you currently serving your country or a recently discharged military veteran? If so, you know your branch of service has likely instilled discipline, strong values, a sense of duty, and loyalty. Among those numerous positive outcomes that can result from military service, there’s also another one you might not have thought of — homeownership.
VA loans, administered by the U.S. Department of Veterans Affairs, are government-backed loans offered to members of the military for their service. They differ from other loan products available to the general public by extending favorable terms and conditions to those who qualify.
Here’s a closer look at the steps involved in locking in a VA loan and purchasing or rehabilitating your next home.
Are You Eligible For a VA Loan?
The VA runs a number of different programs that assist active duty and honorably discharged veterans in purchasing or rehabilitating homes. The ways in which the VA assists in this process are numerous and include:
– guaranteeing home mortgages from private lenders (via the Loan Guaranty Program)
– providing direct loans for home purchases
– extending grants and loans to help disabled veterans adapt housing to fit their needs through the Specially Adapted Housing Program.
Unfortunately, a common misconception with VA loans is that they’re an option for the average homebuyer. In truth, VA loans are available only to U.S. veterans, service members, and their spouses (or surviving spouses). Applicants must meet the minimum active-duty service requirements set forth by the VA, and hold an honorable or general discharge due to a hardship, reduction in force, or for convenience of the government. Additionally, requirements can be met if a discharge was due to a service-connected disability.
Anyone applying for a VA-backed loan must get a Certificate of Eligibility (COE) to show a lender they’re qualified based on service history and duty status.
VA Loan Requirements
Anyone applying for a VA-backed home loan with a COE must still meet the lender’s minimum criteria to receive financing. That starts with providing documentation used to verify your military employment history, creditworthiness, and anything that can help paint a strong picture of your overall financial situation.
These documents could include:
- Several recent pay stubs
- At least two years of W-2s
- Bank statements
- Retirement and investment account information
- At least two years of federal tax returns
- Copies of your DD-214 (also known as a Certificate of Release or Discharge from Active Duty)
- For active military, a statement of service letter signed by a commanding officer
Keep in mind that VA mortgages are available for no money down to qualified buyers. Additionally, VA loans are free of private mortgage insurance (PMI) typically added to conventional and FHA-backed loans. This gives borrowers a lot more flexibility in the amount owed at closing, though paying as little as 5% can cut down the all-important VA Funding Fee.
What is the VA Funding Fee? For any first-time VA loan borrower, it’s a fee paid that is calculated as a percentage of the loan amount and used to offset costs of VA backed loans that default (much like the way mortgage insurance works on a conventional loan). The fee also assures the continued availability of VA loans to future service members and veterans.
The VA Funding Fee is adjustable based on whether a down payment is made, but is usually at least 2.3% with no money down and 3.6% for any subsequent (second) use of a VA loan.
Finally, homebuyers should be aware that the VA doesn’t require a minimum credit score. On the other hand, private lenders that issueVA mortgage loans may have their own credit score requirements, typically ranging from 580 to 660.
Top Three VA Loan Benefits
As we mentioned, VA mortgage loans differ in some key ways from traditional home loans due to their outstanding benefits. One is potentially lower interest rates.
Since the VA guarantees a portion of the loan, they’re less risky for lenders because the guarantee helps to protect the lender. As a result, lenders can offer lower rates than you can get with a traditional mortgage. Still, different lenders will offer different rates and terms on VA mortgage loans so it’s worth taking the time to shop around for the best deal.
Another big benefit previously mentioned is that you can finance 100% of the home’s value with a VA loan. That’s almost unheard of outside of VA mortgages and makes the offer fairly exceptional when compared to traditional loans. For the latter, lenders often require borrowers to make a down payment of at least 20% or have PMI tacked onto a monthly payment. That’s a big savings for anyone eligible for a VA loan and one of its top benefits.
A third perk is that VA loans allow borrowers to use what are known as ‘gift funds’ toward down payments and closing costs. Like a conventional or FHA-backed mortgage, the gifted money must come from someone close to the borrower, such as a family member. He or she must write a letter stating no repayment of the money is necessary, and must also disclose the donor’s relationship to the borrower.
Other Things You Might Not Know About VA Loans
According to the Journal of Fixed Income, VA loans consistently perform better than FHA-backed loans. One of the biggest factors is the residual income test, or the assessment of a borrower’s ability to pay back the loan.
Residual income is defined as the amount of money a potential borrower has left over each month after all other major expenses are paid. This covers things like food, clothing, gas, and other family necessities. Like any other lender, the VA wants service members and veterans to have a comfortable residual income and to make sure a mortgage isn’t putting excess strain on the household budget. This means borrowers applying for a VA mortgage loan should have a minimum residual income that will depend on their loan amount, the location of the home they’re buying, and how many people intend to live there.
If you’re in the market for a VA loan, you’ll need to know that residual income and debt-to-income ratio (DTI) are the two main financial guidelines for VA lenders. Whereas the residual income looks at monthly expenses and doesn’t nitpick your spending habits elsewhere, your debt-to-income ratio will compare all of the money you spend each month against the money you actually earn or bring in. While the VA encourages its lenders to more heavily weigh residual income over DTI, borrowers with higher debt ratios may need to meet a higher standard for residual income.
Additionally, there are a few other things to keep in mind if you have a VA loan. First, if you’re already in possession of a VA Loan, you can refinance that loan the way you would any other loan; if you fall into financial trouble, it’s possible to get a VA home loan just a few years after a short sale, foreclosure, or bankruptcy. In some cases, borrowers can be eligible just a year removed from a bankruptcy filing date; VA buyers can also pay off their loan early without any penalties, and use VA loan benefits again when moving and buying another home.
The Bottom Line
The purpose of a VA mortgage loan is to provide those who served with safe, secure, affordable housing. The VA is not able to provide a homebuyer with legal services, waive credit and income standards, or offer loans to those who were dishonorably discharged or don’t meet service requirements.
- Anyone with further questions on obtaining a VA mortgage loan should visit their nearest VA regional office or call 1-800-827-1000.
- U.S. Department of Veterans Affairs, Eligibility requirements for VA home loan programs. Accessed at https://www.va.gov/housing-assistance/home-loans/eligibility/
- VALoans.com, VA Home Loan Down Payment Facts. Accessed at https://www.valoans.com/articles/va-loan-down-payment-facts/#
- Nerd Wallet, VA Home Loan Credit Score Requirements for 2020. Accessed at https://www.nerdwallet.com/article/mortgages/va-home-loan-credit-score-requirements
- Military.com, Understanding the VA Funding Fee. Accessed at https://www.military.com/money/va-loans/understanding-va-funding-fee.html
- The Journal of Fixed Income, VA Loans Outperform FHA Loans—Why? And What Can We Learn? Accessed at https://jfi.pm-research.com/content/24/3/39.abstract
- Veterans United, Explaining VA Loan Residual Income Guidelines. Accessed at https://www.veteransunited.com/valoans/explaining-the-vas-standard-for-residual-income/