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VA Loans: How They Work and Qualifications for 2021

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A VA loan is a mortgage guaranteed by the U.S. Department of Veterans Affairs (VA) exclusively for military borrowers to buy and refinance homes. It allows active-duty service members, veterans and eligible surviving spouses to finance a home with no down payment and lenient credit requirements.

How does a VA loan work?

On the surface, a VA loan works like any other home loan program. You fill out a loan application, provide proof you can repay the loan based on your earnings and credit history and verify you have enough money saved up to cover closing costs.

However, there are some big differences between VA loans and conventional or FHA loans, especially when it comes to how costs and fees are charged and paid.

You don’t pay any mortgage insurance. Most low- or no-down-payment loan programs require mortgage insurance, which covers lenders in case you default on your payments and they have to foreclose. The VA doesn’t require mortgage insurance on any of its loan types.

You have to verify your military service history. The VA home loan benefit is only for military borrowers that have served enough time to meet eligibility requirements.

You can add some of the VA closing costs to your loan amount. One of the downsides to a VA loan is having to pay the VA funding fee cost of 0.5% to 3.6%. The funding fee is charged to offset the cost of the VA loan program to taxpayers and is typically rolled on top of the loan amount, even if you make no down payment.

Your lender can’t charge you more than 1% in closing costs. VA lenders are limited to charging 1% of your loan amount for their fees. That saves you money at closing and makes VA loans more affordable than other government-backed loan programs.

You’re not restricted by federal loan limits. There are currently no VA loan limits, although some lenders may set their own maximums similar to the conforming loan limits for conventional loans. Currently, the conforming loan limit is $548,250 for a single-family home in most parts of the country.

VA loan qualifications: Are you eligible?

Not everyone can qualify for a VA loan. Besides meeting the VA loan requirements for income, assets and credit, you’ll need to meet the guidelines for military service.

You may be eligible for a VA home loan if:

You meet the minimum service requirements. Your DD Form 214 will reflect the number of years you served in the military.

According to the VA, you meet the minimum service requirement if you served at least this amount of time:

  • 90 continuous days of active duty
  • 90 consecutive days during wartime
  • 181 days during peacetime
  • More than six years in the National Guard or Reserve

You’re borrowing on your own or with an eligible co-borrower. To be eligible for no down payment, you must borrow on your own, with a spouse or with another eligible veteran. If you don’t, you may need to make a down payment.

You have a maximum debt-to-income (DTI) ratio of 41%. Your DTI ratio measures your total monthly debt (including your new mortgage payment) divided by your gross (before-tax) income. The VA recommends a maximum 41% DTI ratio, but exceptions are possible if you have enough residual income.

You meet the residual income test. Residual income calculates how much free cash you have each month based on your after-tax income. The minimum required depends on your home and family size, as well as the location of your home.

You don’t have any federal debt defaults. VA-approved lenders use the Credit Alert Interactive Reporting System (CAIVRS) to check for defaulted federal debt, such as past VA loans or student loans.

You have a two-year employment history. Lenders prefer a steady, two-year job history but may make exceptions for recently discharged veterans.

Your credit score is at least 620. Although the VA guidelines don’t require a minimum credit score, many lenders set their minimum at 620.

You plan to live in the home as your primary residence. You can’t use a VA loan to buy a second home or investment property.

Types of VA loans

Military borrowers can use a VA loan to buy, refinance, renovate or even build a home. Here’s a look at the most common types of VA loans:

VA no-down-payment purchases

The VA loan is the only government-backed mortgage program that requires no money down and no income or loan limits. In some cases, you can even buy more than one home with no down payment using your VA bonus entitlement.

VA cash-out refinances

Eligible VA borrowers can tap equity up to 90% of their home’s value with a VA cash-out refinance — that’s 10% more than conventional or FHA cash-out refinances allow.

VA interest rate reduction refinance loans (IRRRLs)

Homeowners with a current VA loan may lower their interest rate and roll the VA closing costs into their loan with a VA IRRRL. An added bonus: No appraisal or income verification is required.

VA renovation loans

Military borrowers can purchase or refinance a fixer-upper home and roll remodeling and repair costs into the loan with a VA renovation loan. Even better: You can finance up to 100% of the home’s value, which is more than home improvement loan programs allow.

VA supplemental loans

Smaller home maintenance project costs can be financed with a supplemental VA loan. The extra amount can be added to your current loan or taken out as a separate loan.

VA energy-efficient loans

You may be able to finance up to $6,000 worth of costs for “going green” and potentially save on your utility bills with a VA energy-efficient mortgage (EEM). You can combine the VA IRRRL with an EEM without documenting income, as long as your new payment doesn’t increase by more than 20%.

VA construction loans

You can build a house with no down payment using the one-time close or two-time close VA construction loan program. The one-time close option covers the cost of building the home and automatically converts to the permanent loan when the home is complete. The two-time close actually involves two loan closings: One for the dedicated construction loan to build the home, followed by a second for the new loan that pays off the construction loan.

What you need to apply for a VA loan

If you’re ready to get a VA loan, these are the steps you’ll usually take:

  1. Find out if you’re eligible for a VA loan. Get your online VA certificate of eligibility or fill out VA Form 26-1880 and mail it with your DD Form 214 to the address on the form.
  2. Gather your financial paperwork. Besides your VA paperwork, plan on providing a month’s worth of paystubs, two years’ worth of W-2s and 60 days’ worth of bank statements. Provide letters to explain gaps in your employment history, credit issues or large deposits into your bank accounts.
  3. Shop for a VA-approved lender. Make sure you’re working with a VA-approved lender. Check with at least three to five lenders and compare loan costs. Choosing a company that’s knowledgeable about VA loans may avoid headaches down the road.
  4. Lock in your interest rate and pay for a VA appraisal. Your rate isn’t finalized until you lock it in. You can also expect to pay more for a VA appraisal than with one for a conventional or FHA loan to verify the value of the home you’re buying or refinancing. However, if you’re eligible for the VA IRRRL program, you can skip the appraisal fee.

VA loan benefits and drawbacks

Pros Cons
  No down payment required

  No loan limits

  No income restrictions

  No mortgage insurance required

  Lender costs are capped at 1% of loan amount

  Flexible qualifying requirements

  Options for a no income verification/no appraisal refinance

  Must be eligible based on military service

  More stringent appraisal requirements

  Mandatory waiting periods between refinances

  VA funding fees up to 3.6% of loan amount

  Higher appraisal costs than conventional or FHA loans

  Must occupy the home as your primary residence

VA loan FAQs

How many times can I use my VA loan benefit?

You can use your VA loan benefit as often as you wish, as long as you have sufficient entitlement to buy a home and are purchasing a primary residence.

Do VA loans require PMI?

No. Instead, the VA offers a “guarantee” that covers the cost of VA-approved lender losses equaling up to 25% of your loan amount if you default. The VA also charges a funding fee of 0.5% to 3.6% to offset the program cost to taxpayers.

How much are VA loan closing costs?

You’ll usually pay 2% to 6% in VA loan closing costs depending on your loan size. However, VA-approved lenders can’t charge more than 1% of your loan amount for loan-related fees including origination, doc prep, underwriting and other miscellaneous fees.

What is the required down payment for a VA loan?

Eligible veterans typically don’t need any down payment. However, you may need one if you have an outstanding VA loan on another home, and don’t have enough entitlement to cover the guarantee on the new loan.

Can I refinance my VA loan to lower my rate?

Yes. The VA IRRRL program makes it easy to refinance to a lower rate with no income verification or appraisal required.

 

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