VA Construction Loans: What They Are and How They Work

The U.S. Department of Veterans Affairs (VA) offers VA construction loans to help current military service members, veterans and eligible spouses build the home of their dreams. While you won’t have to make a down payment, there are other qualification requirements and hoops you’ll need to be prepared to jump through.

What is a VA construction loan?

New construction loans are short-term mortgages designed to cover the home’s cost. With a typical VA home loan that doesn’t involve new construction, you receive a lump sum from the lender and use it to buy an existing home. When you’re building a home, however, a VA construction loan will disburse money in installments as you build. Each installment, called a “draw,” is used to pay for only the portion of the home completed at that time.

VA construction loans are an attractive option because they offer lower interest rates than conventional construction loans, don’t require a down payment or private mortgage insurance (PMI) and have no maximum loan limit. They also offer the perk that you won’t start paying for the construction loan until after the construction is complete.

There are two types of VA construction loans to choose from:

→ One-time close loans: You take out one loan that covers all of the construction costs. Once the house is built, the loan automatically converts to a regular or “permanent” loan, which you’ll have for the remainder of the loan term. This is typically referred to as a construction-to-permanent loan.

→ Two-time close loans: With this option, you close on two different loans. The first loan is exclusively for the construction of the home. A new loan is taken out to pay off the construction loan balance when the home is completed. The process is similar to a mortgage refinance.

VA loans are only offered in 15- and 30-year terms, but there is no penalty for paying off a loan early.

Rules and restrictions on VA construction loans

There are many rules you’ll need to navigate if you pursue a VA construction loan. 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 are free to choose any builder you want as long as they are willing to go through the VA approval process.
• 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. This includes Puerto Rico, Guam, the Virgin Islands, American Samoa and the Northern Mariana Islands.
• You may be approved if you have a debt-to-income (DTI) ratio higher than 41%, which is the listed maximum for qualification, 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, and a down payment could be required on a subsequent VA loan if you don’t pay off the existing one.

How the VA construction loan process works

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 seven steps:

STEP 1. Confirm VA loan eligibility. You can verify your eligibility by applying online for your Certificate of Eligibility (COE) or filling out a VA Form 26-1880 and sending it to the nearest regional VA office.

STEP 2. Get preapproved for a VA home loan. Once you’ve found a lender that offers VA construction loans, you’ll need to meet VA guidelines and minimum mortgage requirements:

• Credit score. There’s no VA-set minimum, but most lenders require a score of 620 or higher.
• Residual income. Unique to VA loans, residual income measures how much take-home pay is left for a borrower’s living expenses after subtracting monthly debts and home maintenance costs. The minimum requirements vary based on loan size, family size and the location of the home.
• Debt-to-income (DTI) ratio. Your DTI, or total monthly debt divided by gross monthly income, shouldn’t exceed 41% — still, you may be approved with a higher DTI ratio if you meet the residual income requirement.
• Down payment. No down payment is required.
• Occupancy. The home must be a primary residence.

STEP 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.

STEP 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.

STEP 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.

STEP 6. Get a 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.

STEP 7. 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 officially 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.

Fees and expenses to expect with a VA construction loan

There are many fees that can pop up as you build a home. Many of the following fees are common to all home loans, but the VA has some special rules and fees of its own that you should be aware of.

The borrower is responsible for:

• VA funding fee. You must pay this fee within 15 days of closing in the case of a single-close loan, and within 15 days of the permanent loan closing in the case of a two-close loan. 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 $500 to $1,200, depending on where you live. State-by-state VA appraisal fees are listed online.
• Closing costs. The average paid in closing costs across all homebuyers is around 1% of the total loan amount, but VA borrowers may pay even less because there are fewer closing costs. VA loans also have no restrictions on where the money to pay these costs can come from.
• Origination fee. This is typically charged by the lender as part of the closing costs.
• Down payment (optional). If you choose to make a down payment, it will 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.

The builder is required to pay for:

• Inspection fees
• Hazard insurance (during construction)
• Commitment fees
• Title update fees
• Interest payments (during construction)
• Property taxes (during construction)

Pros and cons of a VA construction loan vs. a regular construction loan