Pros and Cons of a VA Loan

Pros and Cons of VA Loans

Benefits of VA Loans

VA loans are a perk designed to help those who've served in the U.S. military forces buy a home. They're provided by private banks and lenders, and backed by the VA. Here's an overview of the benefits they may offer prospective homebuyers.

Competitive Interest Rates

VA loans may offer interest rates that are, on average, lower than you might qualify for with a conventional home loan. The Department of Veterans Affairs backs a portion of VA loans; in other words, if a borrower were to go into foreclosure on a VA home loan, the lender would be able to recoup a portion of their investment. Because VA lenders face less risk, they can afford to offer better mortgage rates and terms. For buyers, this translates to lower monthly payments and significant savings on interest over the life of the loan.

Learn more: How Do VA Loans Work?

No Down Payment

With a conventional mortgage, most lenders require that you make a down payment of at least 3% to 5%. If you're buying a home with a VA loan, you may not be required to make a down payment at all.

In general, you won't be required to make a down payment on your home as long as the purchase price of the home doesn't exceed its appraised value. So, for example, if you offer $350,000 on a home that then appraises for $350,000 or more, you won't be required to make a down payment. On the other hand, if the home appraises for $340,000, you'd typically be required to put down $10,000 to make up the difference.

The vast majority of VA loan home purchases are made with no down payment, according to the Department of Veterans Affairs. So, if coming up with a large down payment poses a barrier to buying a home, a VA loan could open the door. That said, keep in mind that you'll still need some cash reserves to cover closing costs and the VA fee (more on this below).

Learn more: VA Loan Requirements

No Mortgage Insurance Requirement

Another unique benefit of buying a home with a VA loan is that VA loans come with no mortgage insurance requirements.

Private mortgage insurance (PMI) is a type of insurance that borrowers are typically required to pay for if they put less than 20% down on a conventional mortgage. It's there to help reduce the risk of loss for the lender in the event that a borrower stops making payments on the loan.

But, since VA loan lenders are already sheltered from some risk thanks to VA backing, there's no PMI requirement for VA loan borrowers. That means that you won't have to come up with a 20% down payment to avoid the cost of PMI.

Tip: Not all government-backed loans waive the mortgage insurance requirement. Loans insured by the Federal Housing Administration (FHA) require mortgage insurance for the life of the loan, or for 11 years with a minimum 10% down payment.

Learn more: How Your Down Payment Affects Your Mortgage

May Be Easier to Qualify For

VA loans are designed to make homeownership attainable for veterans. For example, the cost of a down payment (or the added expense of PMI) could be a hurdle to buying a home, but VA loans remove those obstacles.

VA loans may also come with more flexible debt-to-income (DTI) requirements. DTI measures how much of your income goes toward debt payments each month. For a conventional mortgage, you may need a DTI lower than 36% to 43% for approval. Some VA lenders may consider borrowers with DTIs as high as 50%, though they'd likely require the borrower to meet other requirements, such as a higher credit score and documentation of ample cash flow.

Learn more: What Credit Score Do I Need to Buy a House?

VA Loans Are Assumable

VA loans are assumable. That means that a buyer can take over a VA loan on a house, keeping the same interest rate and loan balance. The buyer doesn't need to be a veteran, but they'll need to meet applicant requirements set by the lender, such as credit score or income requirements.

Assuming a VA loan can be a big plus for the buyer, because it could mean saving significant money on interest—especially when rates are on the rise. The buyer will need to pay a funding fee to the VA, but they may be off the hook for some other closing costs. For the seller, advertising an assumable VA loan on a house may help attract buyer interest.

Tip: Making your VA home loan assumable means you can't use the benefit on your next home purchase, because your entitlement will stay with the old home loan. If you'll need your VA loan entitlement to buy another home, this may not be a good option. On the other hand, if the buyer is also a veteran, you could ask them to request a formal substitution to return your loan entitlement to you while still taking over your old mortgage.

Downsides of VA Loans

Closing Costs May Be Higher

Closing costs are a reality for all types of mortgages, but VA loans come with specific fees that you should know about. Like most mortgages, with a VA loan, you can expect to pay standard closing costs including:

• An origination fee (which the VA caps at 1% for VA loans)
• Recording fees
• Title insurance
• Credit report fees
• Real estate commissions (though these may be covered by the seller)

Beyond these costs, VA loans come with their own set of fees. Specifically, you should expect to pay VA appraisal fees, which vary depending on the market you're in and the specific property. You'll also typically need to pay a unique charge called a VA funding fee, which is charged as a percentage of the loan you take out to buy the home.

The exact amount you'll pay in funding fees depends on several factors, including the amount of your loan, how much you put down and whether it's your first time using a VA loan or not.

Example: If you're buying a $300,000 home, it's your first time using the benefit and you put down a 10% down payment of $30,000, you'd be charged a 1.25% financing fee. With a $270,000 loan, the financing fee is 1.25%, or $3,375.

VA funding fees may be waived for certain borrowers, such as individuals who receive VA compensation for a service-related disability or active-duty service members who show documentation of receiving a Purple Heart.

Tip: The financing fee is assessed based on the loan amount, not the price of the home. That means you'll save money in fees by putting more down. You can choose to pay the funding fee as a one-time cost at closing, or spread it out by including it in your monthly loan payments.

Learn more: Everything You Need to Know About Mortgage Fees

Higher Property Requirements

To qualify for a VA loan, the home will need to meet a set of standards known as minimum property requirements (MPRs). MPRs are there to protect the buyer by ensuring that the home is structurally safe and sanitary. To ensure the home meets MPRs, you'll need to undergo a VA appraisal as part of the closing process.

VA appraisals share some similarities with a typical mortgage appraisal, but they may be more detailed. The appraiser will check to see that the property meets the specific guidelines set by the VA. If a home is in need of significant repairs, it may be difficult to get financing through the VA. For example, a roof that needs replacing or signs of termites or other pest issues could cause a home to fail VA appraisal.

Tip: In cases where a VA loan appraisal uncovers repairs necessary to meet MPRs, the buyer and seller will need to negotiate to determine who'll pay for what and perform the repairs before closing on the home.

Can Only Be Used for Your Primary Residence

VA loans come with occupancy requirements: You must live in the property as your primary residence. To close on the home, you'll need to certify that you intend to move into the property within a "reasonable amount of time," which the VA may define as within 60 days of closing.

If you're on active duty, occupancy by your spouse or dependent child counts toward the requirement. You may also meet occupancy requirements if you're considered to be in temporary-duty status.

So, you can't use a VA to buy a second home. That may not pose an issue for most buyers, but it's important to keep in mind if you're considering using a VA loan for a vacation spot or a source of rental income.

On the other hand, if owning a rental property is your goal, keep in mind that you can use a VA loan to purchase a multifamily property, as long as you'll occupy one of the units. You're restricted to a property with no more than four units. So, for example, you could use a VA loan to buy a duplex and live in one unit, renting out the other for income.

Tip: You can also use a VA loan to purchase a retirement home in a desired location if you show documentation of a set retirement date within 12 months, at which point you'll need to move into the home to meet occupancy requirements.

Limited Eligibility

By design, VA loans are only available to:

• Veterans
• U.S. active-duty service members
• Qualified surviving spouses

Should You Use a VA Loan?

Whether or not you should use a VA loan comes down to your personal financial situation and goals, and whether you could get a better deal elsewhere. If you're qualified for a VA loan, then the benefits—including lower rates, no down payment and no mortgage insurance requirement—could make it an ideal option for buying a home. On the other hand, it may not be a good fit if you have a significant down payment and can find a less expensive option with another type of loan, or you're buying an older home that may not meet minimum property requirements.

Another reason you might choose to go with a conventional mortgage over a VA loan is if you're buying in a highly competitive market. When sellers have their pick of offers, they may choose a seller with a conventional loan over one with a VA or another government-backed loan. Since VA loans come with stricter property requirements, sellers may feel more confident accepting a conventional mortgage offer, since there are fewer hoops to jump through in order to close.

Overall, VA loans are a great option for eligible buyers, especially those who don't have a significant down payment, so it's likely worth consulting with a local real estate agent for a sense of how VA financing can fit into your larger strategy for buying a home.

Learn more: How to Buy a House: Step-by-Step Guide

Alternatives to VA Loans

While VA loans offer clear perks, they may not always be the right option for you. Here are some other options to consider:

• Conventional loans: Conventional loans can be a good option if you're able to meet minimum requirements for qualification, which could include a credit score of around 620 and a DTI lower than 36% to 43%. Another thing to keep in mind is that if you can't afford a 20% down payment, then a conventional mortgage typically requires that you pay for PMI. That can add to your monthly housing expenses.
• First-time homebuyer programs: Look into local new homebuyer assistance programs to see what type of help may be available to you. Depending on where you live, you may be able to qualify for a mortgage with a low down payment requirement, mortgage rate reductions or down payment assistance.
• FHA loans: Federal Housing Administration (FHA) loans are a type of government-backed mortgage designed for borrowers who may struggle to meet borrower requirements on conventional loans. Their features include lower down payment and credit score requirements.
• USDA loans: U.S. Department of Agriculture (USDA) loans are a type of low-interest mortgage with no down payment requirement designed for borrowers in eligible rural and suburban areas. They can be more accessible to borrowers with poor credit, and are only available to borrowers whose income falls below a certain threshold for their area.

Learn more: FHA vs. VA Loan: Which One Is Right for You?

The Bottom Line

VA loans can be a great homebuying option for those who qualify because of their lower rates, lack of mortgage insurance requirement and no down payment requirement, plus lowered barriers to qualifying for the loan. But the right mortgage type for you will come down to your personal goals and the property you want to buy. Speaking with a real estate agent can help you get a stronger sense of your options.

Whatever loan type you use, improving your credit may help you qualify for better rates. You can check your FICO^® Score^☉ and credit report for free to see where your credit stands now. From there, learn about how to improve your credit before you buy a house.