How does a VA loan work?

VA loans operate similarly to private mortgages. The interest rate you qualify for will depend on the same factors (income, debt, and credit score), and most private mortgage lenders offer VA loans. However, because the government guarantees a portion of the loan, the lender is able to offer a few advantages for qualified buyers. To qualify for a VA loan, you must be a current or former service member, National Guard or Reserve member with an honorable discharge. The loan is also available to spouses of veterans who died on duty or as a result of military service.

Advantages to a VA loan

VA loans generally offer long terms and competitive interest rates. VA loans also limit debt-to-income ratio at 41%, which is higher than most conventional mortgages. This means borrowers with more debt may still qualify for lower interest rates. VA loans also do not require a down payment (usually 10-20% of the value of the house). Because the loan is government backed, the buyer is not required to pay private mortgage insurance - usually required with low down payments. Furthermore, VA loans limit the amount of closing costs a buyer pays.

In addition to upfront savings, VA loans offer several advantages in the long run. The government offers qualified VA loan borrowers a loan modification program, if at any point the borrower has difficulties making repayments. VA loans also make it easier to refinance to a lower rate within the program. They also offer the buyer the right to pay the loan balance early without penalty. And finally, VA loans are assumable, which means they can be transferred directly from seller to buyer (as long as both are VA qualified). If interest rates have risen since the seller took out the original mortgage, you will benefit from assuming the mortgage with lower interest rates.

Disadvantages

One disadvantage to VA loans is that most charge a funding fee, which is typically around 2% of the loan. In addition, because VA loans are sold in a secondary market, most loans are limited to $417k. If you were looking to purchase a home above this limit, you would have to seek a conventional mortgage.

The Bottom Line

As always, remember to shop around and compare offers from several different lenders. It is not a bad idea to include some conventional mortgages in your comparisons as well - although VA loans offer many advantages, you may still find a better deal elsewhere. For qualified borrowers, a VA loan is a very good option, but not the only option. 

Veterans fall into a special category of potential homeowners, and therefore, may have access to special lending privileges under the Veteran Affair (VA) loan category that civilians do not.  Those who are eligible to receive VA loans do not need to meet typical down payment requirements, and can instead buy a home with little or no money paid up front.  Veterans or spouses of former veterans are also frequently not held to the same credit-worthiness that non-VA loan borrowers are held to.

In order to qualify as a Veteran, you must meet one of these minimum conditions:

• 181 days of active duty service during peacetime
• 90 days of active duty service during wartime
• 6 years of service in the Reserves or National Guard
• Spousal death in the line of duty, or due to a service-connected disability

Keep in mind that these eligibility requirements may qualify you for a VA loan, but you still need to meet the same lender requirements that most civilians do.  In fact, the Veterans Affairs office itself doesn’t even issue the loans.  Instead, it guarantees the down payment amount typically needed to allow veterans to borrow from traditional lenders without any money up front.

What’s nice about this guarantee from the VA, is that typically, borrowers without the full 20% most traditional lenders demand must pay private mortgage insurance until their home equity value meets 20% of the home’s appraisal value.  VA loans do not require this, allowing veteran homeowners the ability to either save this money, or pay down their mortgage more quickly.

To find out more information, visit benefits.va.gov.  If you’re ready to purchase a home, look for a lender that participates in the VA home loan program.  You’ll need to obtain a Certificate of Eligibility, but other than that, the home buying process is exactly the same as it would be for a civilian.