How Does a VA Construction Loan Work?
The U.S. Department of Veterans Affairs (VA) offers its own construction loan to help eligible military members build their dream homes. While VA construction loans come with some perks (like no down payment requirements), they’re also subject to specific rules and regulations. Here’s what you need to know before applying.
What is a VA construction loan?
Similar to other types of construction loans, a VA construction loan is a type of short-term financing that’s meant to help you cover the cost of building a home.
The loan is backed by the U.S. Department of Veterans Affairs (VA), however, meaning it’s only available to eligible active-duty service members, veterans and certain military spouses. That said, if you qualify, this loan comes with many benefits that may make it an advantageous choice over a standard construction loan.
For one, VA construction loans offer lower interest rates than standard loans. They also don’t require a down payment, and those who choose not to make one won’t be subject to private mortgage insurance (PMI).
The VA offers two types of construction loans for you to consider:
- One-time close loans: As a form of construction-to-permanent loan, the one-time close loan covers all of your construction costs and then automatically converts to a “permanent” mortgage once the build is complete. You’ll keep the permanent mortgage for the remainder of the loan term or until you decide to refinance your loan.
- Two-time close loans: In this type of transaction, you’ll actually be using two different loans. The first loan will cover the costs of construction. Once it’s over you’ll take out a standard VA loan to pay off the construction loan.
Eligibility requirements for a VA construction loan
VA construction loan lenders typically look for borrowers to meet many of the same eligibility requirements as they would for a typical VA loan, including:
- Certificate of eligibility: A certificate of eligibility (COE) is a military-issued document that proves you meet the minimum service requirements to qualify for a VA loan. You’ll have to request yours from the VA.
- Credit score: While the VA technically doesn’t have a minimum credit score requirement, individual lenders may follow their own guidelines. For most lenders, a score of 620 or above is generally preferred.
- Down payment: Similarly, the VA itself doesn’t impose a down payment requirement. However, you may need one for some lenders, especially if you already have an existing VA loan.
- Income: VA lenders look at your residual income — the amount of money you have left over after making your monthly debt payments — when deciding whether or not to approve you for a loan.
- Debt-to-income ratio: You can find your debt-to-income ratio (DTI) by dividing the sum of your monthly debts by your gross monthly income. For VA construction loans, lenders generally look for a DTI of 41% or less.
- Property requirements: The VA imposes minimum property requirements (MPRs) to ensure that the homes it backs are safe, sanitary and structurally sound. In addition to meeting those requirements, you’ll have to get a VA-approved appraiser to say that the after-construction value of the property is satisfactory for the loan amount.
- Closing costs: You’ll still have to pay closing costs, but there’s a closing cost cap on VA loans, which ensures that lenders don’t charge exorbitant fees. It’s equal to 1% of the loan amount.
Rules and restrictions specific to VA construction loans
On top of the above requirements, VA construction loans have additional rules you’ll need to follow. Here are some of the most important ones to be aware of:
- You must use a VA-approved builder (or get your builder approved): You’re free to choose any builder you want, as long as they are willing to go through the VA approval process.You can also select an established builder from the list of VA-registered builders.
- You can’t buy undeveloped or vacant land: Unless you begin construction on a house right away, you aren’t allowed to buy a parcel of land with no housing on it. If you’re not ready to build yet, consider a VA land loan, which can be paid off later with a VA construction loan.
- You need to build a home that will be your primary residence: VA loans can’t be used for building investment or rental properties.
- Your house must be connected to utilities and paved roads: If you’re interested in extremely rural or off-grid living, a VA loan probably isn’t right for you.
- You can’t buy or build a house outside the United States: If you want the expat experience, your best bet is to build or buy in U.S. territories or possessions. These includes Puerto Rico, the Virgin Islands, American Samoa, Guam and the Northern Mariana Islands.
- You may be approved if you have a high debt-to-income (DTI) ratio:The listed maximum to qualify is 41%, but you may still be approved for a loan as long as you meet the residual income requirements.
- You can have more than one VA loan at a time: The maximum loan amount may be limited. However, a down payment could also be required on a subsequent VA loan if you don’t pay off the existing one.
How to apply for a VA construction loan
The VA construction loan process is similar to the process for a regular construction loan, with a few extra hurdles. The process typically follows these steps:
1. Confirm VA loan eligibility.
2. Get preapproved for a VA home loan.
Once you’ve found a lender that offers VA construction loans, you’ll need to be preapproved for a loan to get a sense of how much you can afford to spend on your home build.
3. Submit construction plans and specs.
The new home must meet minimum property requirements set by the VA. Your builder should fill out Form 26-1852 with a description of all of the building materials and submit it (along with a copy of the building plans) for approval.
4. Ensure your builder is registered with the VA.
Once you choose a builder, the company must register with the VA and obtain a VA Builder ID number. The VA loan guaranty web portal provides a list of VA-registered builders to veterans registered with AccessVA.
5. Close on your loan.
Now is the time to pay your closing costs, including your VA funding fee, and celebrate — your loan is now a legally binding contract, and construction can proceed.
6. Authorize draws with each construction phase.
Rather than being disbursed all at once, construction loan funds are doled out in segments known as “draws.” As the borrower, you’ll have to sign off on each draw in writing as each phase of construction is completed.
7. Get a final home inspection.
Once construction enters its final stages, the property must be inspected to confirm that what was built meets VA minimum property requirements (MPRs) and local building code guidelines.
8. Prepare for the permanent loan to kick in.
If you have a one-time construction loan, the permanent loan payment schedule will begin automatically when the home is finished. The payment will be based on the full balance of the loan. With a two-time close, you’ll replace the construction loan with a new mortgage.
Common VA construction loan fees
Many of the following fees are common to all home loans. However, some of the fees that would normally be the borrower’s responsibility fall to the builder with a VA construction loan. The VA also has some special rules and fees of its own.
- VA funding fee: You must pay this fee within 15 days of closing. The fee covers the costs of guaranteeing the loan but is waived for several categories of veterans and spouses, including disabled vets and recipients of the Purple Heart. It is also the only fee that can be rolled into the purchase loan.
- Appraisal fees: VA appraisal fees can vary from around $525 to $1,550, depending on where you live. State-by-state VA appraisal fees are listed online.
- Closing costs: The average closing costs for all homebuyers is around 2% to 5% of the total loan amount, but VA borrowers may pay even less because there are fewer closing costs to cover. VA loans also have no restrictions on where the money to pay these costs can come from.
- Origination fee: An origination fee is typically charged by the lender as part of the closing costs in exchange for doing the administrative tasks necessary to open a new loan.
- Down payment (optional): If you choose to make a down payment, it’ll lower your loan amount — saving you money on interest in the long run. If you put at least 5% down, you can also pay a reduced VA funding fee.
- Construction fee: The lender is allowed to charge additional flat charges of up to 2% of the loan amount.
- Inspection fees
- Hazard insurance (during construction)
- Title update fees
- Interest payments (during construction)
- Property taxes (during construction)
Pros and cons of a VA construction loan
No down payment is required.
Easier qualifying guidelines for income and credit history than other construction loans.
Veterans with a service-related disability may get the VA funding fee waived. The funding fee is an upfront, one-time fee charged to offset the costs of the VA loan program to taxpayers.
No mortgage insurance is required for VA loans.
Some VA closing costs can be rolled into the loan.
Not all VA-approved lenders offer VA construction loans.
Inspection time and VA form requirements may slow down the process.
VA appraisals may take longer and be more expensive than you’d otherwise encounter.
VA interest rates for construction loans may be higher because they require longer-term rate locks.
The funding fee may be as high as 3.6% of the loan amount for second-time VA home loan users.