Why VA Home Loans Still Make Sense
For all the problems at the Department of Veterans Affairs, there is one bright, shining light: The VA home loan is still a godsend for veterans.
Easier Qualification Standards
It’s not so much the interest rate. People with excellent credit can qualify for marginally better interest rates with conventional mortgages than with VA loans. But consider this: According to mortgage software and data company Ellie Mae, it’s taking a credit score of well over 768 these days to qualify for the best rates in the conventional mortgage market. People with credit scores in the 600 range? Many of them aren’t qualifying for mortgage loans at all.
Over the last year, mortgage rates have fallen as low as 3.35 percent last December, and again in May, before rebounding to around 3.9 percent on June 1, 2013. Think about it from a lender’s perspective: That doesn’t leave much margin for defaults. With rates that low, lenders have become extremely picky about who they are willing to lend money to – even where these loans are secured by real estate.
A VA loan, however, is guaranteed by the U.S. government. That means that the taxpayer has stepped in and guaranteed the lender that they will not experience a loss on the loan. If a VA borrower defaults, the Department of Veterans Affairs makes up the difference to the lender.
This means that VA loans are a lot less risky to the lender than conventional loans. In turn, this means that lenders tend to be more willing to consider loans to those with less-than-stellar credit scores.
Furthermore, since a VA loan is guaranteed, the lender will not require private mortgage insurance, or PMI. Lenders typically require borrowers to buy this insurance if their loan-to-value ratio (LTV) is 80 percent or greater.
What does this mean? It means that if you owe more than 80 percent of the current value of the home, you have to keep paying PMI premiums. For most homeowners, this will add between $1,500 and $2,500 to your first-year home ownership costs.
The worst part is that the homeowner derives no benefit from this insurance. It protects the lender, not the borrower. But for VA borrowers, there’s no PMI requirement – even on deals that require nothing down. That’s enough of a difference to offset most or all of the lower monthly payments you might get with excellent credit if you made the same deal with a conventional loan.
(Hint: Home prices have gone up quite a bit over the last two years. If you have been paying PMI premiums, think about getting your home appraised, or requesting an appraisal from the lender. If a qualified appraisal pegs your home value at 80 percent or more of the outstanding mortgage balance, the lender has to drop PMI premiums. That’s money that goes back into your pocket.
Furthermore, VA loans do not have a pre-payment penalty. Lenders occasionally charge this to other borrowers to shield themselves from reinvestment risk – the possibility that borrowers will refinance their loans if interest rates fall, forcing the lender to reinvest the money at a lower interest rate.
But Congress realized that military families have to move a lot – and therefore have to pay off loans repeatedly with each PCS, through no fault of their own. They therefore wrote rules that prevent VA lenders from charging a pre-payment penalty. Typically, this is an amount equal to six months’ worth of interest if you try to refinance or pay off the loan within the first five years. With a VA loan, on the other hand, you can pay down the loan early and often. This makes the VA solution an ideal option if you plan to move in a relatively short period of time, and ideal for those facing PCS moves every three or four years. If you don’t go with a VA loan, then look carefully at the prepayment terms of your mortgage, because they will likely kick in when you refinance.
Many people look at the fact you can get into a VA loan with no down payment as the greatest benefit to a VA loan. But if you can’t swing a 10 to 20 percent down payment on a home, that’s a pretty good sign you can’t afford it! The underwriters figured that out long ago. Furthermore, VA borrowers aren’t immune to swings in house prices, and with zero down, even a slight downward tick in house prices leaves the borrower “underwater,” meaning you will owe more on the house than it is worth. Translated into real world terms, it means that if you do need to sell, you will either need to come up with cash at closing, or you will need to get the lender to agree to a short sale – which they may not be willing to do.
If you do go with a zero down loan, try to have something stowed somewhere else, outside of a retirement account, earning interest or dividends for you. Ideally, this pot of money should be invested in something besides real estate – so that if the value of your home falls, this other stash of money doesn’t fall with it. It’s just another safety net to see you through tough times. The good news: The fact that the VA does allow for no-down-payment mortgages gives you the flexibility to keep your savings in something more liquid than home equity.