There’s plenty to like about VA loans, the mortgage product insured by the U.S. Department of Veterans Affairs and available to current and former members of the U.S. military. The biggest draw of a VA loan? You can qualify for one without providing any down payment dollars, something that makes this product especially attractive to first-time homebuyers or borrowers without a stuffed bank account.
VA loans also don’t require mortgage insurance, something that can’t be said of other loan types. This can save borrowers $100 or more on their mortgage payments.
But does this mean that VA loans are always the best choice for veterans or active-duty military personnel? Not necessarily. The VA loan is a strong product, but it’s not perfect, thanks largely to a funding fee that lenders charge when originating these loans.
That funding fee, which varies depending on the borrower and the number of times a borrower has taken out a VA loan, might make these loans too expensive. In these cases, buyers might be better off applying for a conventional mortgage, one not insured by a government agency, or an FHA loan, one insured by the Federal Housing Authority.
VA loans are often the smartest choice
Still, mortgage lenders say that for many veterans, the VA loan will be the smartest financial choice.
Rob Greenbaum, vice president of sales and marketing with AAFMAA Mortgage Services in Fayetteville, North Carolina, said that VA loans are almost always a good choice for veterans, active-duty service members and the spouses of deceased military members.
"VA mortgages are exclusively available to current and former service members, which can be seen as a major benefit because they are catered specifically to these individuals and often take the unique financial challenges of military life into account," Greenbaum said.
VA loans, of course, aren't open to everyone. You must be an active-duty member or veteran of the U.S. military or National Guard or military reserves. You can also qualify for a VA loan if you are the spouse of a military member who died while on active duty or because of a service-connected medical condition. Spouses can't qualify for a VA loan if they have remarried.
If you are eligible, VA loans are often a good choice to help you get into a home.
Compare VA loans to other loan types. FHA loans require small down payments of just 3.5 percent of a home's purchase price if your FICO credit score is 580 or higher. But while 3.5 percent is a low down payment, it's still higher than the 0 percent down payment you can qualify for with a VA loan.
Consider a $200,000 home. A down payment of 3.5 percent on such a home would cost you $7,000 in down payment dollars. If you take out a VA loan with no down payment, you won’t have to worry about coming up with those dollars.
Also, FHA loans require that you pay both an upfront and annual mortgage insurance fee. That annual fee never goes away. VA loans don't require any mortgage insurance payments.
A better choice than conventional, too?
VA loans also compare favorably to conventional mortgage loans, those not insured by a government body. It's possible today to qualify for a conventional mortgage with a down payment as low as 3 percent of a home's purchase price. Again, though, that's not nearly as good as having to come up with no down payment at all.
And if you don't come up with a down payment of at least 20 percent, you'll have to pay private mortgage insurance, or PMI, on your conventional loan. Again, VA loans don't require this insurance payment.
The funding fee can hurt
That isn't to say that there isn't at least one drawback with a VA loan. You’ll have to pay a funding fee of 2.15 percent of your mortgage amount when taking out a VA loan with no down payment. Say you are taking out a VA loan for $200,000 and you’re not putting anything down, that funding fee will come out to $4,300.
You can reduce that fee to 1.5 percent by coming up with a down payment of 5 percent or more of your home's purchase price. You can drop the funding fee to further to 1.25 percent with a down payment of 10 percent.
The funding fee is higher for members of the reserves or national guard. They'll have to pay 2.4 percent of their loan amount. If you are the surviving spouse of a veteran who died in service or from a service-related disability, you will not have to pay a funding fee.
This fee will increase if you take out a second VA loan, say after selling your first home and buying a new one. If you are veteran or active-duty member of the military or of the Reserves or National Guard you'll pay a funding fee of 3.3 percent when taking out a VA loan a second time, or any other time, if you choose the zero-percent down payment option.
Jammie Jelks, a mortgage consultant with Green Box Loans in Los Angeles, said that while VA loans are attractive, they also come with certain requirements that limit the number of people who can qualify for them. There are the military and service requirements, of course. But there are additional requirements even if you meet these initial eligibility rules, Jelks said.
First, you must occupy the home you are buying as a primary residence, Jelks said. You can't use a VA loan to buy a second home or investment property.
Lenders will also look carefully at your three-digit credit score, Jelks said. Most lenders will want to see a FICO credit score of at least 620, he said. Stable income is important, too, Jelks said. Lenders want to make sure that your income stream stays steady each year so that you can afford your monthly mortgage payments.
When does a VA loan not make sense?
Does it ever make sense for those who qualify for a VA loan to not take one out? Mark Klein, founder of PCL Financial Group in Westlake Village, California, said that it all depends on the funding fee. That fee, especially if you don't come up with any down payment, can be hefty, and might outweigh the other benefits of a VA loan.
"That fee can be inhibitive," Klein said. “That’s really the main reason why you might pass on a VA loan.”
Klein, though, does recommend that those who are eligible for a VA loan at least investigate the product. Even with the funding fee, the loan might be the best financial choice. Buyers who take out a VA loan don't have to pay the funding fee upfront. They can roll it into their total mortgage. This will make their monthly payment a bit higher each month but can make the fee less of a financial burden.
And if your biggest challenge is coming up with the cash for a down payment, rolling the funding fee into the loan and going with the VA's no-down-payment option might be the best choice for you.
"It is always worth the time to see how a VA loan compares with the other options," Klein said. "It might not pay off, but it might be the best loan option for you."