How the Loan Program Works
By Peter Gaytan
The VA doesn’t directly lend you the money for a mortgage (except for Native Americans on trust land or to supplement a grant to get a specially adapted home for certain eligible vets). You apply to a lender (banks, savings and loans, mortgage companies). The difference is you have the backup of the Federal government. The VA guarantees a certain amount of the loan to the lender, usually about 25 percent. That means the institution can offer these loans, at competitive rates with no down payment to even those borrowers with bad credit, because unlike conventional mortgages, there is little or no risk involved to the institution. The Federal government has guaranteed that if the borrower doesn’t repay the loan, the government will.
Choose Your Lender Carefully
If possible, choose a lender who has “automatic basis” status. This means the lender can make the credit decision on the loan without VA approval. While a VA appraisal is still required, you save time because there’s no need to await VA approval. Not all lenders have the authority to process loans on an automatic basis – ask before beginning the loan application process. Lenders approved to participate in the VA’s Lender Appraisal Processing Program (LAPP) can usually expedite the processing of VA appraisals.
How Much Can You Borrow?
In 2005, the VA effectively raised the amount that a veteran could borrow for a home. It’s now $417,000(and even higher in areas with a high cost of living like Alaska, Hawaii, Guam, and the U.S. Virgin Islands). How does the VA decide on the limit? It’s tied to the standard loan that lenders sell to Freddie Mac (Federal Home Loan Mortgage Corporation, a government-sponsored company that acts as a secondary mortgage market investor to buy and sell loans.) The maximum VA guarantee is 25 percent of the current Freddie Mac conforming loan for a single-family residence. The guaranteed amount can rise or fall, depending on current market conditions. The amount is determined on January 1 of each year.
The guaranteed portion of a VA loan is called an entitlement. The amount of entitlement relates to the amount VA will guarantee the lender against loss. Basically a veteran can borrow up to $417,000 with no down payment. The actual money comes from the lender.
For loans over $417,000, the lender will most likely ask for a down payment of around 25 percent of the remaining balance. For example:
Home $450,000 (including all closing and other fees)
VA Home Loan: $417,000 including funding, closing, and other fees
Remainder: $33,000 that can either be paid using a down payment provided by
the veteran or the veteran must pay at least 25 percent of the difference to have the remainder added to their loan.
Confused? If you need help figuring out how much of an entitlement you are eligible for, or the limits on loans, work with the loan officer at the bank or ask a service officer of a Veterans Service Organization for a more detailed explanation.
There are advantages and disadvantages to a VA guaranteed loan. As with any financial decision, consider all your options before making a commitment.
The advantages of a VA loan are:
- No down payment
- Easier credit qualifying than conventional mortgage
- Lower closing costs
- No monthly mortgage insurance
- Loan is assumable
- VA loan includes funding fees (2 percent of the loan amount, slightly higher for reservists), although they may be rolled into the loan and are waived for vets with service-related disabilities. If you make a down payment, the funding fee is reduced. Keep in mind that conventional mortgages also have closing costs.
- VA requires that the property meets certain minimum standards at appraisal. If the property doesn’t meet those standards, and if the owner refuses to make required repairs, the buyer must either pay for the repairs himself, switch to conventional financing, or find another property.
What Kinds Of Closing Costs Are Permitted?
One of the advantages of a VA loan is that there are lower closing costs. While there can be no commission or brokerage fees charged for obtaining a VA loans, here are the costs that are permissible: VA appraisal; credit report; survey; title search; recording fees; a one percent origination fee; discount points. These can add up to a considerable out-of-pocket expense for the buyer because the closing costs and origination charge may not be included in the loan, except for VA refinancing loans. You will want to negotiate with your lender your interest rate, as well as the payment of discount points and other closing costs. For example, some mortgage brokers will waive the cost of a credit report. There are many VA-approved lenders – negotiate to get the best deal.
Next week: VA Loans: Pick the One Right for You
Peter S. Gaytan is the author of For Service to Your Country, The Insider’s Guide to Veterans’ Benefits (Citadel, 2008), available from Amazon, Barnes and Noble, and other booksellers. He has served as an advocate in securing and protecting the earned benefits of America’s veterans for more than a decade. Gaytan is the Executive Director of the American Legion, the largest veterans service organization in America.
*Material released with permission of the authors.