There are several VA loan programs that cover a wide range of financing activity. The VA home loan benefit serves everyone from first-time homebuyers, existing homeowners who want to refinance to disabled veterans who want to make their home more accessible. For example, the VA benefit can be used to:
- Buy a home, condo or townhouse
- Build a home
- Improve the energy efficiency of a home
- Refinance an existing mortgage
- Repair, alter or renovate and improve a home
- Buy and improve a home (at the same time)
Loans are made to eligible veterans to purchase homes in which they will live (also known as owner-occupied). Sorry, you can’t use your VA benefit to buy an apartment building or a house with the intention of renting it out.
Below you will find an overview VA mortgage programs.
VA Purchase Loans
The first notable aspect of a VA loan is that they may be obtained with $0 down payment. That’s the special deal veterans get for serving their country. You won’t find that kind of arrangement anywhere else.
The second notable thing isn’t something the VA loan has but what it does not have; VA loans do not require borrowers to carry Private Mortgage Insurance (PMI). On a non-VA loan, PMI protects the lender should the borrower default on the loan. And the borrower pays a monthly premium until they own at least 20% of the homes value.
For comparison, PMI is required on FHA and Conventional loans when borrowers do not own at least 20% of their home’s value. So if a person owes $90,000 on a home worth $100,000 (they only own 10% of their home) they must must carry mortgage insurance. Until the borrower pays the loan down to around $80,000 (20% of the home), they’ll keep paying. (Note: most conventional loan mortgage insurance goes away automatically when the LTV hits 80% but FHA loans have mortgage insurance for the life of the loan. Which is why borrowers refinance when they hit 80% LTV.)
Here’s the great news about VA Loans: the government carries the insurance on behalf of the borrower.
Aside from the cool zero-down feature and the VA’s guarantee, the VA purchase loan is pretty much your straight up, garden variety fixed rate mortgage. You can choose a term of 15 or 30 years.
15-year mortgages have a lower interest rate than the 30-year version. The lower rate will save you money on the total cost of the loan over time. However, compressing the payment term to 15 years results in a higher monthly payment. Obviously, you’ll own the home free and clear sooner with the 15-year loan. If you’re goal is to own a home outright sooner rather than later, this is probably the best way to accomplish it.
30-year mortgages have a slightly higher interest rate than a 15-year loan but spreading the payments out over a longer timeframe results in lower monthly payment. The higher interest rate means to total cost of the loan is higher over time. But people naturally lover a lower payment (helps them qualify for a bigger home) which is why the 30-year loan is so popular.
Here are a few other notable features that will be covered in more detail throughout this guide:
- VA loans are not just for first-time homebuyers
- Your VA benefit can be used more than once
- The seller may pay your closing costs
- The loans are assumable
VA Cash-Out Refinance
VA Cash-Out Refis (pronounced “reef eyes”) are cousins to purchase loans. The same set of guidelines apply. However, in this case, the borrower has an existing mortgage that they want to replace. During the replacement, they convert some of the built up equity into cash.
The maximum loan amount cannot exceed 100% of the home’s value, inclusive of fees. Which means there will be an appraisal required. And there will be a standard underwriting package which includes credit reports, etc. With the Streamline Refinance, borrowers are not burdened with either of these.
Borrowers should consider the ramifications of pulling equity out of a home. In some cases, borrowers get into a habit of pulling equity out of their home every few years. The trouble is that they are not building anything of value. Their home is treated as a giant ATM machine.
There will be a VA Funding Fee for every refinance which adds to the cost of converting the equity to cash. Are you annoyed by paying $2 to withdraw a few bills from an ATM? Well, the “ATM Fee” to withdraw equity from a house will make that $2 ATM fee look quite small.
The final result of habitual refinancing is that the borrower never inches his or her way toward owning a home free and clear. Not having mortgage payments in retirement is a great way to go; being financially secure at age 70 sounds pretty sweet.
Is there are way to know if it’s a good or bad idea? Well, “good” and “bad” are relative, but here’s some practical advice.
Cash out refis can be potentially good if the money will be used for:
- Remodeling – because the cash is put back into the home as an equity-building project.
- Energy Efficiency – because there will be a return on the cash in the form of lower energy bills; it’ actually possible to calculate how long an investment in a particular solar installation or appliance will pay for itself. Though all of this is predicated on owning the home long enough to reap that benefit.
- Buying another income-producing property
Generally, cash outs are a bad idea if:
- The money will be used on a car or other depreciating assets
- The money will be used on a vacation or other things that aren’t an asset at all
- The money will be used to buy equities (stocks) or any other risky asset
- Paying off credit cards without a plan to curtail the use of revolving credit going forward. Yes, people can pull out calculators and show you how rolling your debt into your mortgage can lower monthly costs (spreading out your credit card bills over 30 years) but do you really want to pay for that snowboard you bought on your credit card for the next 3 decades? And what good does it do if a borrower — now free of credit card debt through a refinance — immediately “maxes out” his or her cards again?
That leads me to the second kind of loan that is potentially “good” or “bad” depending upon the borrower’s circumstances, Adjustable Rate Mortgages.
VA Hybrid Adjustable Rate Mortgage (Hybrid ARM)
From the 1960s to the mortgage crisis in 2008 many people fell in love with Adjustable Rate Mortgages (ARMs). That’s because there was a really nice “carrot” for folks who got them; ARMs had lower interest rates than 30-year fixed mortgages. Therefore, borrowers had lower monthly payments. Lower payments also meant qualifying for a bigger loan, i.e. you got a bigger house. This sounds pretty good until you here that there’s a catch. More on this below, but first let’s talk about how ARMs work.
ARM Interest Rates
There are two underlying components make up an ARM’s interest rate. They are the index and margin. The index is the part that fluctuates. It’s tied to a third-party market index such as the 1-year Treasury Bill. The second component is the margin and it’s added on top of the index.
Lenders borrow at the market index rate and then add their margin (usually a couple percentage points) to make their profit.
Index + Margin = Full Indexed Rate
For example, if a lender borrows money from the market 1-Year Treasury rate of 5% and add 2.5% margin, the borrower’s interest rate is 7.5%.
Here’s what went wrong for a lot of folks in the early 2000s. ARM mortgages — being fluid in their interest rate — often adjusted to a higher interest rate. When rates went up, monthly mortgage payments went up. That put some folks in a very crummy position; they could no longer afford their home. Ouch.
Traditional ARMs have interest rates that adjust every X number of years. “X” could be every year, every two years and so on.
In the interest of protecting borrowers, the VA (and it’s governmental cousin the FHA) have been more conservative about ARM guidelines. They limit what kind of adjustable rate loans they’ll guarantee. Instead of “pure” ARMs with frequently changing interest rates, the VA offers a Hybrid (a mash up of a fixed rate and adjustable rate mortgage) called a “VA 5/1 ARM”. Here’s how they work:
- The 5/1 Hybrid ARM carries a lower, fixed interest rate for five years. This is called an initial period.
- On the fifth year, there is an adjustment period where the loan’s interest rate converts from fixed to adjustable. At the time of the first adjustment, market rates can be higher or lower than they were in the beginning of the mortgage. While VA added some protections (fixed rate for five years) borrowers still need to be really cautious with ARMs.
- The maximum initial adjustment is 1%.
- The rate continues to change each year — by a maximum of 1% — for as long as the borrower holds the loan.
- While the interest rate can wiggle around and inch up by 1% each year at each adjustment period, there is a final protection for the borrower called a lifetime cap. The interest rate cannot increase more than 5% over the life of the loan.
In some ways, the “guardrails” of the 5/1 Hybrid ARM protect folks from the whipsaw of market interest rates. However, the worst case scenario of hitting the 5% cap can still happen. And it would have a material impact on folks who are trying to stay in their home and make their monthly mortgage payment.
For example, if a borrower takes out an ARM that is initially 5% (3% index + 2% margin), the interest rate on their loan could eventually be 10% if it hits the lifetime cap. The monthly payment difference is:
- 5% puts the monthly principal and interest at $1,342 (doesn’t include taxes or insurance)
- 10%puts the monthly principal and interest at $2,193 (doesn’t include taxes or insurance)
That’s a difference of $851 per month or $10,212 per year. Not a trivial sum. This can easily be the difference between putting a kid through college or not.
Interest Rate Reduction Refinance Loan (IRRRL)
As mentioned above, the previous two types of VA programs can be tricky. Caution is strongly advised. So it’s with a bit of relief that we now get to talk about a great program, the Interest Rate Reduction Refinance Loan (IRRRL) pronounced “Earl” also known as VA Streamline Refinance.
This program converts an existing VA loan into a new VA loan with a different (typically lower) interest rate and term. You can convert a fixed rate loan into a new fixed rate loan or you can convert an ARM to a fixed rate mortgage.
- Must be VA to VA refinance, meaning only on properties where the borrower has previously used a VA entitlement
- No appraisal required
- No underwriting package is required, meaning no credit report is pulled
- No cash out
- A new Certificate of Eligibility is not required
- Maybe be done with no money out of pocket by including all costs into the new loan or the lender can set an interest rate high enough that the lender pays the costs
- Funding fee is .05%
If you can save money on your monthly mortgage payment because a Streamline refinance is lowering your interest rate, why wouldn’t you? It makes a ton of sense.
However, folks should be careful about serial refinancing. Why? Here are two reasons:
- Every time loans are refinanced, there are loan fees to handle things like processing, underwriting, etc. Repeating these same fees over and over — via successive loan refinancing — adds up. There’s a little bit of value “erosion” going on each time. Any more than one or two refinances and the erosion is quite noticeable.
- Also, every time there’s a refinance, the term gets reset. Some borrowers never seem to whittle down the number of years they must make mortgage payments. The best case scenario is for borrowers to eventually refinance from a 30-year term to a shorter 15-year term. If a borrower keeps refinancing to the same 30-year term, they will never own a home free and clear.
VA Energy Efficient Mortgage (EEM)
The VA’s Energy Efficient Mortgage (EEM) helps subsidize home improvements if they help reduce the monthly cost of ownership, namely the cost of heating or cooling your house. Borrowers can get $3,000 to $6,000 to spend on things like solar heating/cooling systems, insulation, water heater wraps or replacing old appliances with energy-efficient ones. The EEM is available for new homes purchases or alongside a refinance. Part of qualifying for the EEM requires some paperwork that demonstrates the projected cost savings on monthly utility bills should the improvements be made.
Native American Direct Loan (NADL) Program
Native American veterans may apply for loans directly from the VA for home purchases, construction, or home improvements on Federal Trust Land. There’s also a NADL program to refinance an existing NADL loan. Borrowers should contact their VA regional loan center about this program.
Housing Grants for Disabled Veterans
Veterans with certain service-connected disabilities may qualify for grants for constructing or adapting a home to accommodate the disability. These grants work in conjunction with VA-guaranteed home loans.
For example, Special Housing Adaptation (SHA) grants funds can be used as a down payment at closing when purchasing a home that has already been adapted. Specially Adapted Housing (SAH) grants can offset the total construction cost of a new, adapted home. There are also grants for assistive technology such as voice recognition and living environment controls that could aid or enhance a Veteran or Sermicemember’s ability to live independently.
Veterans should work with personnel at their nearest VA Regional Loan Center to determine if and how a SAH or SHA grant can be applied.
Veterans may use adaptive housing grants up to three times as long as they don’t exceed the total grant limit. Current grant limit amounts can be found at VA’s Website.
VA Reverse Mortgage
If you’re looking for a VA Reverse Mortgage, they actually don’t exist. An alternative government-backed program would be HUD’s Home Equity Conversion Mortgage (HECM) backed by the FHA. There are also private reverse mortgage programs available.