The Pros and Cons of Using a VA Home Loan

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Veterans sacrifice a lot in service of their country so it’s not surprising that they’re entitled to certain special perks of civilian life. One of those perks is the ability to obtain a no-down payment VA home loan.

VA loans have been useful tools for veterans to use to buy a home over the years, but in 2021’s hot real estate market, they are “often regarded with suspicion,” according to an article by The New York Times. While VA loans can be the most advantageous financing option for a veteran looking to buy or refinance a home, they’re not without drawbacks. During this hot home-selling period, sellers have shied away from VA loans because they often come with smaller down payments and less upfront money, making it harder for veterans using VA loans to close on homes.

But are VA loans really “bad” for sellers? In this piece, we’ll explain VA loans, examine the pros and cons of VA loans for both buyers and sellers, and determine whether veterans can still rely on them as a legitimate home buying option.

What is a VA loan?

The VA loan program is administered by the Department of Veterans Affairs (VA), but a VA loan itself is not actually offered by the government. Instead, loans originate from VA-approved lenders like select banks, credit unions, and mortgage companies. Through this system, the VA guarantees a VA loan — meaning that if a borrower defaults, the VA will refund a portion of the outstanding balance to the lender.

This guarantee from the VA allows lenders to provide great terms for VA loans to veterans. Most VA loans come with the following benefits:

  • No down payment required
  • No private mortgage insurance (PMI) required
  • Low interest rates
  • Streamlined refinancing option via the Interest Rate Reduction Refinance Loan (IRRRL)

Because of such outstanding terms, veterans, active-duty military, and surviving spouses must qualify for a VA loan. For active duty, that means 90 consecutive days of service. For National Guard or Reserve members, it’s 90 consecutive days if you’re activated, or six consecutive years if you aren’t. For veterans, the required service times vary based on when you served.

Pros of a VA loan for buyers

We just laid out some of the major pros of a VA loan for buyers, but there are other benefits of a VA loan over conventional mortgage financing as well.

Touching on the previous advantages, purchasing a home without having to make a down payment or paying for mortgage insurance could save you tens of thousands of dollars. With a conventional loan, you must put down at least 3% of the home’s total price as a down payment. If you put down less than 20%, you’ll have to pay mortgage insurance that may cost a few hundred dollars every month.

VA loans also offer lower interest rates than both fixed-rate or adjustable-rate mortgages. Usually, it’s about a half-percent lower. Again, across a 30-year mortgage that could mean thousands in savings.

Additionally, the VA doesn’t impose a minimum credit score requirement on borrowers, and accepts a higher debt-to-income (DTI) ratio. Many lenders will require a FICO score of 620 or higher, however, so buyers with low credit scores may find their options limited. Still, it’s easier to qualify for than a conventional loan.

Finally, VA loans tend to have lower closing costs since the VA limits the origination fee a lender can charge to no more than 1% of the mortgage.

Pros of a VA loan for sellers

VA loans are obviously beneficial for buyers, but why should sellers accept them when the terms are so heavily in the buyer’s favor? We’re glad you asked.

First, VA loans have less stringent underwriting criteria. Because the government guarantees VA loans, VA-approved lenders approve more applicants compared to conventional lenders. So, if a seller has two comparable offers, someone with a VA loan may have a much easier time qualifying for a loan (even for an eventual higher amount) than someone who is going through conventional lenders.

VA loans also close at a higher rate than conventional ones despite having a few extra steps. Sellers, then, can feel confident that closing will go through without a hitch when working with a VA home loan buyer.

Finally, the increased purchasing power allotted to buyers through VA loans can also benefit sellers. A 3% down payment on a $400,000 home is $12,000. Not everybody has that cash lying around. Even with qualifying income and credit, getting that 3% down payment may prove challenging. While a conventional buyer would need at least a $12,000 down payment for a $400,000 home, a buyer using a VA loan wouldn’t have to worry about the down payment. As long as the bank agrees, a VA buyer could raise their offer to $450,000 without increasing the amount of money they put down, while a conventional buyer would have to come up with $13,500 to raise their offer to $450,000. 

Cons of a VA loan for buyers

Like anything in real estate, VA loans are not perfect. There are drawbacks for buyers as well.

First, despite not paying for mortgage insurance, you will pay a funding fee at closing. If you’re taking out your first VA loan and not making a down payment, the funding fee is 2.3% of the total amount you’re borrowing. If you do put money down or you’ve gotten a VA loan in the past, the fee may range from 1.4% to 3.6%. Closing costs may be less, but they’re not absent.

VA loans may also only be used for a primary residence, not for an investment property or vacation home. For most people, that isn’t a big deal, but if you’re looking for a wealth creation opportunity, a VA loan won’t work for you.

VA loans also offer less flexibility in the purchasing process. You can’t waive contingencies like the home inspection or appraisal. While some conventional buyers waive these rights to make their offer more attractive to sellers, VA home buyers cannot do so.

Cons of a VA loan for sellers

While selling to VA loan buyers isn’t the best option for most sellers in a very competitive market when you’re fielding multiple increasing offers, in a normal market, there aren’t many cons. Still, you should understand how basic elements of VA loans work so you’ll have an easier time selling.

First, the VA has Minimum Property Requirements (MPRs). It mandates that properties have baseline levels of habitability, meaning they must be safe, sound, and sanitary. To meet these objectives, the VA has MPRs that all homes must meet in order to qualify for a VA loan. Again, most sellers won’t have to worry about this as the typical buyer doesn’t want to buy a shanty for a primary residence. Still, it’s important to know the VA will inspect a home.

Likewise, the VA also completes an appraisal for any home that a VA loan buyer wants to buy. In addition to MPR compliance, the VA appraises the property to ensure it’s selling for a fair price and the buyer won’t default on the loan. In a competitive market, this might be a pain for sellers. In a normal market, it’s standard operating procedure.

Finally, because of the risk of deployment, it’s very common for service members using VA loans to close via power of attorney. It’s not necessarily a con, but if you want to know who you’re selling to, this may catch some sellers by surprise. It’s possible that you will never meet the buyer. If that’s a dealbreaker, for whatever reason, you’ve been forewarned.

VA loan alternatives

If you don’t qualify for a VA loan, you’re not out of options. Consider the following options instead:

  • Conventional loan: As we’ve explored in this piece, conventional loans don’t have the same perks that VA loans do, but with so many options on the market, you can search for a good loan that works for you.
  • FHA loan: FHA loans are backed by the government and require an upfront mortgage insurance premium, sort of like the VA loan’s funding fee. You will also pay a mortgage insurance premium, however, and you may have a higher interest rate.
  • USDA loan: USDA loans require zero down payment but are only for borrowers in designated rural areas. There are income and property restrictions and they only support 30-year fixed-rate financing.

VA home loans have gotten a bad rap in a competitive market. But as the housing market slowly normalizes, they’ll continue to be a useful tool for veterans and active service members looking to buy a primary residence. While sellers may prefer the flexibility of conventional home loans in a hot market, VA loans can actually be more appealing in a normal one. In the end, when using a VA loan, buyers and sellers can both benefit.

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