What is a VA loan

How a VA loan works

VA loans are a special type of mortgage backed by the U.S. Department of Veterans Affairs (VA). These loans are provided exclusively to veterans, active-duty service members and surviving spouses of the U.S. military.

If a borrower is unable to repay a VA loan, the VA will reimburse part of the outstanding loan amount to the mortgage lender. This reduces the risk that a lender assumes and allows for less restrictive mortgage approval requirements.

Here are some of the key advantages of VA loans:

• No down payment: Unlike traditional mortgages, VA loans do not require a down payment. This means that eligible individuals can purchase a home without having to save a large sum of money first.
• Competitive interest rates: VA loans often offer low interest rates, which can save borrowers money over the life of the loan.
• No private mortgage insurance: Most conventional mortgages require borrowers to pay for private mortgage insurance (PMI) if they don't make at least a 20% down payment. VA loans do not require PMI, which can save you money each month.
• No prepayment penalty: VA loans do not have a prepayment penalty, allowing you to make extra payments or pay off the loan early without incurring any fees.
• Lifetime benefit: The VA home loan is a lifetime benefit for eligible individuals. This means that even if a borrower has previously used a VA loan, they may still have the opportunity to take out another VA loan in the future, either for purchasing a different home or refinancing their current home.

VA loan vs. conventional mortgage

A conventional mortgage is a private loan not backed by the government. The terms and requirements of a conventional mortgage can vary depending on the lender. But they generally involve a minimum down payment requirement and PMI for borrowers who put down less than 20%, as well as certain minimum credit score and income criteria.

One restriction with VA loans is that they’re limited to borrowers who intend to use the mortgaged property as a primary residence. Conventional mortgages, on the other hand, may allow borrowers to purchase any type of property.

Here’s a brief comparison of VA loans and conventional mortgages:

Types of VA loans

There are several different types of VA loans. The most suitable type of VA loan for you will depend on the amount you need to borrow, how you plan to use the loan and your individual profile as a borrower.

“Choosing the right VA loan hinges on individual circumstances and objectives,” said David A. Krebs, the principal broker at DAK Mortgage in Miami. “For first-time homebuyers, a VA purchase loan would be fitting. If reducing your monthly mortgage payment is your aim, an IRRRL could be an ideal choice.”

VA loan eligibility

The VA does not set a minimum credit score requirement for VA loan eligibility, but lenders typically do. Most lenders require a credit score of at least 620 to obtain financing.

However, VA loans do have specific criteria regarding permitted property types and a borrower’s military background. VA loans also have a debt-to-income (DTI) ratio limit of 41%. This means that your monthly debt payments, including your mortgage payment, cannot exceed 41% of your monthly gross income.

Property type and occupancy requirements

To be eligible for a VA mortgage, a property must be located in the U.S. or its territories and considered habitable. The VA also has some specific requirements for the size and foundation type of a manufactured home.

The VA requires borrowers to occupy the property they purchase with a VA loan as their primary residence for at least 12 months. This means you generally cannot rent out the property or use it as a vacation home. There are some exceptions to this rule, such as if you are on active-duty military orders or are a reservist who is called to active duty.

Military service requirements

Current service members, veterans, members of the National Guard and Reserve members may be eligible for VA loans. Eligibility varies depending on these factors:

• Length of service
• Time period in which the service was completed
• Nature of the service
• Type of discharge received

There are a few eligible borrower profiles among those who have not served in the U.S. military, such as the surviving spouses of veterans or the spouses of veterans who are missing in action or being held as prisoners of war.

» MORE: VA loan credit score requirements

Pros and cons of VA loans

While VA home loans offer advantages such as no down payment or PMI, they also come with more rules and regulations than conventional mortgage loans.

For example, there are limits as to how a VA-backed property can be used, and the home will have to undergo a VA appraisal. If the home doesn’t meet the VA’s standards, the VA won’t approve the loan. As such, sellers may view selling to a buyer with a VA mortgage as too much hassle.

Here are some of the key benefits and drawbacks of a VA mortgage:

How to apply for a VA loan

Applying for a VA home loan isn’t that different from applying for a conventional mortgage. But there are a few additional steps worth noting, including ensuring your lender is approved by the VA, obtaining specific paperwork and getting a VA-specific appraisal.

Select a VA-approved lender

You’ll need to find a lender approved by the VA. While it may seem like any lender will do, it's crucial to choose a lender with expertise in VA loans. Opting for a VA specialty lender can make the loan process easier and faster.

Obtain a Certificate of Eligibility

A Certificate of Eligibility (COE) serves as evidence of your eligibility for VA loan benefits and indicates the amount of entitlement you can receive. The VA guarantees this amount on your VA loan.

In most cases, you can get your COE instantly online through a lender's portal or via the VA’s website. If you're unable to acquire it online, you can request it by mail. Your VA lender or the VA itself can guide you to the appropriate resource based on your circumstances.

Get a VA appraisal

Your lender will order the VA appraisal for the property. Note that only appraisers certified to perform appraisals to VA standards can evaluate the home being considered for VA financing.

The VA appraiser assesses the value of the home and ensures it meets the VA's minimum property requirements. However, a VA appraisal does not replace a home inspection, which focuses on code violations, defects and the overall condition of the property.

The appraisal can take seven to 21 business days to complete, depending on the home’s location.

Pay VA fees and closing costs

During closing, you'll sign documents that confirm your agreement with the loan terms. You’ll also need to pay closing costs. While most home purchases and refinances come with closing costs, VA loans also include a VA funding fee and VA appraisal fee.

The VA funding fee depends on the type of loan and your down payment, but will generally be no more than 3.3% of your loan amount. VA appraisal fees range from $525 to $1,550, depending on the type of home and its location.

Bottom line

Access to a VA loan is a privilege earned through selfless service. And if you're a U.S. military member, veteran or surviving spouse, a VA loan can make your dream of owning a home a reality.

These mortgages, backed by the government, provide numerous advantages, including no down payment, competitive interest rates and no need for PMI.