mortgages

What Is a VA Loan and How Does It Work?

9 Minute Read

When it comes to buying a house, finding the right home is just half the battle. The other half is figuring out how to pay for it.

If you’re a veteran or currently serving in the military, you have a mortgage option that isn’t available to other Americans—the VA loan.

A VA loan is backed by the Department of Veterans Affairs and is designed to help U.S. veterans, active duty service members, and widowed military spouses buy a home. This type of loan is an attractive option because it’s pretty easy to qualify for and doesn’t require a down payment.

But is a VA loan your best option? Let’s take a closer look at what a VA loan is, how it works, and whether or not you should buy a home with it.

What is a VA loan?

In 1944, VA loans were introduced as part of the GI Bill, but they’ve become increasingly popular in recent years. Through the first half of 2018, 8% of home purchases were made with a VA loan.(1)

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This loan is one of the two nonconventional (or government) loans available today. Like a conventional loan, VA loans are issued by private lenders like banks or mortgage companies, but they’re insured by the government. VA loans are specifically guaranteed by the Department of Veterans Affairs. That means the VA agrees to repay a portion of the loan to the bank if you don’t make your payments (default) or if you face losing your home (foreclosure).

Since the banks assume less risk compared to a conventional loan, VA loans are relatively easy to get. In fact, the VA guaranteed more than 740,000 home loans in 2017, breaking all records from previous years.(2)

Here are some of the key features and benefits of a VA loan:

  1. You can buy a home with no down payment. VA loans are one of the last zero-down home loans available today. More than 80% of these loans are made with no down payment.(3)

  2. There is no limit to the amount you can borrow on a VA loan, but there is a limit to the amount of liability the VA takes on. For 2018, the VA will guarantee a maximum of 25% (up to $113,275) of a home loan amount, which corresponds to a maximum loan of $453,100. Anything beyond that won’t be guaranteed by the VA. Sound dangerous? It can be!

  3. You won’t have to pay Private Mortgage Insurance (PMI). Since the loans are backed by the government, you can kiss PMI goodbye!

  4. There’s no minimum credit score requirement. But lenders still look for borrowers with a credit score of 620 or higher. But who needs a credit score anyway? Not you!

  5. A VA loan can only be used to buy or build a primary residence or to refinance an existing loan. So you can forget trying to buy an investment property or vacation home with one. (Besides, that’s a bad idea with any loan.)

  6. Only certain types of properties are eligible for a VA loan. Vacant land and co-ops don’t qualify. Other types of properties are up to the lender’s approval.

  7. The VA offers assistance for struggling borrowers facing a potential foreclosure. The agency’s loan technicians can negotiate with lenders on behalf of borrowers who are having trouble making mortgage payments.

  8. There is no prepayment penalty. This means you won’t be fined if you pay off your loan early.

Who is eligible for a VA loan?

In order to get this loan, military personnel need to meet the VA’s specific service requirements. Generally, you’re eligible if you fall into one of the three categories below:

  • You are an active duty service member or an honorably discharged veteran who has 90 consecutive days of active service during wartime or 181 days of active service during peacetime.

  • You have served more than six years in the National Guard or the Selected Reserve.

  • You’re the spouse of a service member who died in the line of duty.(4)

If you were to go through the application process, you would need a Certificate of Eligibility (COE) to show mortgage lenders that you qualify for a VA loan. You can apply for a COE through the VA website or by mail—or through your lender.(5)

You don’t need to be a first-time home buyer in order to get a VA loan. As long as you pay it off each time, you can use the benefit again and again.

And if you’ve filed for bankruptcy or gone through a foreclosure, you can still qualify for a VA loan after a year or two has passed.

What are the drawbacks of a VA loan?

This all sounds great so far, right? But if you dig a little deeper, you’ll find some serious problems with this type of loan.

First, the zero down payment is not really an advantage; it’s a dangerous trap. In that scenario, a small shift in the housing market might leave you owing more on your home than its market value. That means you could get stuck with the home until the market recovers or take a financial loss if you have to sell the house in a hurry.

On top of that, VA loans require you to pay a funding fee between 1.25% to 3.3% of the loan amount. On a $300,000 loan, that fee can be anywhere from $3,750 to $9,900. And the fee is usually included in the loan, so it increases your monthly payment and adds to the interest you pay over the life of the loan. Plus, you might need to factor in origination fees from the lender. Yikes!

While interest rates for 30-year VA loans are usually equal to or slightly lower than 30-year conventional fixed-rate loans, neither loan is a good option. Both will end up costing you much more in interest over the life of the loan than their 15-year counterparts. And more often than not, you can get a lower interest rate on a 15-year fixed-rate conventional loan than you can on a 15-year VA loan. We can prove it.

Is a VA loan worth it?

Let’s say you put no money down on a 15-year VA loan for a $200,000 house at 4.625% interest. We’ll assume your funding fee is $4,300 and include it as part of the loan. Your monthly payment, principal and interest, is $1,576, and your total interest paid over the life of the loan winds up being $79,374.

When you factor in the base loan amount, the funding fee and the total interest paid, the entire cost of the VA loan is $283,674.

But what if you decided to save up a 20% down payment on that home and go with a 15-year fixed-rate conventional mortgage instead? Well first, you’d end up with a better interest rate at around 4.125%, and you would also have no PMI. Your monthly payment would be around $1,194, saving you hundreds of dollars each month.

But you really see the savings when you look at the interest paid over the life of the loan. With a 15-year fixed-rate conventional loan, your total interest paid is $54,839—that’s almost $25,000 less than what you paid in the VA loan example.

When it’s all said and done, the total cost of the 15-year fixed-rate conventional loan—including the down payment—comes out to $254,839. That means you would have saved $28,835 more over the life of the loan if you went with a 15-year fixed-rate conventional loan over a VA loan. I’m sure you can think of some great ways to use that kind of cash!

The bottom line is this: VA loans are usually one of the most expensive ways to buy a home. If you have to take out a loan in order to buy a home, go with a 15-year fixed-rate conventional mortgage with a 20% down payment (to avoid paying PMI). Outside buying your home with cash, it’s the best way to go.

DESCRIPTION 15-YEAR VA LOAN 15-YEAR FIXED RATE
Base Loan $200,000 $160,000
Interest $79,374 $54,839
Down Payment $0 $40,000
Fees $4,300 $0
Total Cost of Loan $283,674 $254,839

Need help with a mortgage?

This is a lot of information to take in. But don’t panic! We know learning about mortgages and all of the different options available can be overwhelming. The good news is, when buying a house, you don’t have to make this decision alone!

If you’re looking for an experienced lender who will help answer all your mortgage questions and equip you to make the best decision for you and your family, we recommend Churchill Mortgage. For more than 25 years, their mortgage experts have coached hundreds of thousands of people on how to buy a home the right way.

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