What Is a VA Loan and How Do They Work?

If you're an active member of the military or a military veteran who's looking to finance a home, you may want to look into VA loans, which offer many benefits that other types of mortgages do not. Here, we'll discuss how VA loans work and the pros and cons of a VA mortgage.

A VA loan is a mortgage that's guaranteed by the U.S. Department of Veterans Affairs. Though the money you borrow to finance your home will come from a private lender, the Department of Veterans Affairs will step in and back that loan to make it easier for you to qualify.

How does a VA loan work?

Once you're deemed eligible for a VA home loan, you'll receive what's called your "entitlement," or the amount the Department of Veteran Affairs will guarantee on your loan in the event you go into default. However, your lender may be willing to let you borrow more than the guaranteed amount, and you'll often get to borrow four times your entitlement.

There are two types of entitlement you can qualify for:

• Basic entitlement: Either 25% of the mortgage or $36,000 -- whichever is lower
• Bonus entitlement: This is up to 25% of the Federal Housing Finance Agency conforming loan limit minus the basic entitlement. For most of the U.S., that limit is $510,400, and 25% of that is $127,600. Subtract from that the basic entitlement of $36,000, and you're left with $91,600 -- the maximum bonus entitlement you might get.

If your basic entitlement does not secure you a high enough loan to buy the type of home you want, you can combine your basic entitlement with your bonus entitlement to secure a higher mortgage. Remember, you can generally borrow four times your entitlement. With a basic entitlement, that would give you a $144,000 loan, but in expensive areas of the country, that’s not enough to buy a home. As such, you could then combine your basic entitlement with your bonus entitlement for a total entitlement of $127,600, then borrow up to four times that much -- $510,400.

VA loans can often be secured with no money down, though you'll need to prove that you have the necessary income to keep up with your monthly mortgage payments. Technically, there's no minimum credit score requirement for a VA loan, but the higher your score, the greater your chances of getting approved.

You may have a hard time getting a VA loan if your credit score isn't at least 620. There are mortgage options for poor credit, so in some cases, you may be able to qualify with a lower score. If your score isn’t great, it pays to work on building or rebuilding your credit before you apply.

Furthermore, you can only use a VA loan to purchase a primary home. You can't take out a VA loan to buy a vacation home or investment property. You can use a VA loan to buy one unit of a condo or townhouse, but the VA must evaluate the community before approving your loan.

You must meet at least one of these requirements to qualify for a VA loan:

• Be an active member of the military, or be an honorably discharged military veteran
• Put in 90 consecutive days of active service or more during a period of war, or 181 consecutive days of service or more during a period of peace
• Have more than six years of service in the National Guard or Selective Reserve

If you have a spouse who died in the line of duty, you may be eligible for a VA loan as well, even if you never served yourself.

Home loans generally come with closing costs and fees, and VA loans are no exception. You may be able to roll your closing costs into your mortgage and pay them off over time, rather than upfront. Your closing costs may include, but aren't limited to:

• Loan origination and processing fees
• Underwriting fees
• Credit check fees
• Title insurance
• Homeowners insurance (you may need to pay your first year's premium up front)
• Property taxes (it's common to pay a portion of your upcoming taxes in advance)
• Appraisal costs
• Courier fees
• Recording fees

VA loans also come with a funding fee. If you're applying for this type of loan for the first time and you're not planning to make a down payment on your home, that fee will equal 2.3% of your home's purchase price. For subsequent applications, it's 3.6%.

If you're able to make a down payment, your funding fee will be lower. For a down payment of 5% but less than 10%, you're looking at a fee for 1.65%, regardless of whether this is your first VA loan. For a down payment of 10% or more, it drops to 1.40% for a first or subsequent application.

VA loans allow qualified borrowers to put no money down toward the purchase of a home. That flexibility could come in quite handy if you have the income to support ongoing mortgage payments but don't have enough money in savings to come up with a down payment. Additionally, if you have generous friends or relatives, you can use a down payment gift to cover your down payment.

Also, VA loans don't charge private mortgage insurance, or PMI, which is a penalty of sorts that buyers face when they can't make a 20% down payment on a home. PMI generally gets tacked on as an added premium to your monthly mortgage, making it more expensive.

VA loans are also easier to qualify for than traditional mortgage loans, since they're backed by a government agency. As such, lenders take on less risk and are therefore more lenient with their borrowing requirements.

Finally, VA loans tend to offer competitive interest rates. The exact rate you qualify for, however, will depend on factors like your loan amount and your credit score.

Though there are plenty of good reasons to get a VA home loan, there are also some disadvantages you should know about. While you may avoid PMI with a VA loan, you'll instead pay a funding fee that could make your mortgage more expensive -- either up front or over time if you roll that fee into your loan and pay it off in installments.

Also, with a VA loan, you're limited to a primary home only; you can't use one to buy a vacation or investment property. However, you can take out a VA loan to finance the purchase of a home you occupy and then rent out a portion of to generate rental income.

Before you apply for a VA loan, you'll need a Certificate of Eligibility, which you can get through a lender or through the VA's eBenefits portal.

Once you have that paperwork, you can apply for a mortgage online. You'll find that many of the best mortgage lenders offer VA loans, though not all do. In fact, it pays to shop around for a VA loan, because one lender may be able to offer a more competitive mortgage rate than another.

After serving your country, you deserve to have an easy time buying a home. A VA loan could be your ticket to an affordable mortgage and a place to call your own.

Still have questions?

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