VA Loan Pros and Cons

We owe much to those who sacrifice for our country by serving in the military.

One way the nation thanks them is by offering a VA loan as an option that helps active-duty and retired servicemembers afford a home.

Borrowers must meet specific guidelines for these federally backed loans, but they offer a no-down payment option for those who qualify. The government started offering VA loans in 1944 as a way to help servicemembers who fought in World War II. It remains a strong program today.

With this loan, the Department of Veterans Affairs guarantees a portion of the loan, which reduced lenders’ risk and allows them to offer more favorable terms. The loans are available through banks, credit unions or mortgage companies.

Jason Richardson, branch manager of Prime Lending in Austin, Tex., puts the benefits of a VA loan into real terms.

“I was quoting a veteran recently, comparing a conventional loan at 97% [the maximum he can borrow] compared to a VA loan at 100%,” Richardson said. “Not only was the VA rate a little lower, the VA payment was $275 less per month. That’s incredible savings he can invest or save. Even if rates were the same, he still saved about $200 a month.”

This loan is one of the better options for servicemembers, but like any loan, there are positives and negatives that need to be examined before moving forward.

What Are the Pros of a VA Loan?

What are the advantages of a VA loan? There are several – chief among them the ability to buy without a down payment. Let’s take a look at what makes VA loan an attractive option for eligible borrowers and the specific benefits of a VA loan.

No Down Payment Required

Consider that a 10% down payment on a $200,000 home would be $20,000 – or $40,000 if buyers want to put down 20%, which is the standard. Eliminating the down payment removes that barrier to home ownership and  the most attractive benefit to a VA loans. The only caveat to avoiding the down payment: The appraised value of the home might be less than the sales price.

No Mortgage Insurance

Private mortgage insurance (PMI) is one of the annoying parts of buying a home. With traditional loans, anyone who puts less than 20% of the purchase price down must spend more for PMI. This increases the monthly mortgage payment and is required with conventional and FHA loans (though with FHA loans it’s called Mortgage Insurance Premium, or MIP). VA loans have no PMI or MIP attached to them. Borrowers can purchase a home without spending a penny out of pocket (no down payment) and without paying the extra monthly insurance charges.

Lower Interest Rates

Lenders who offer VA loans typically do so at lower interest rates than conventional mortgages. Typically, the rate is about one-half of a percentage point lower than conventional loans. This provides the benefit of a lower monthly payment, which keeps more money in the servicemember’s pocket. Over the course of a 30-year loan, an interest rate reduced by even .5% can save thousands of dollars.

» Learn More: Current VA Loan Interest Rates

Lower Closing Costs

The VA limits the origination fee a lender can charge for a VA loan, which results in lower closing costs compared to conventional loans. The maximum allowed for an origination fee is 1% of the mortgage, according to the VA.

No Prepayment Penalty

Some loans charge a prepayment penalty. That means if you want to pay the loan off earlier than its end date, you are charged for that. VA loans do not have this penalty. Which is a great benefit, because adding even an extra $50 to each monthly payment and applying it to the loan principal will reduce the amount of money borrowed, which means you will pay off the loan sooner.

Assumable Status

If you move and/or sell your home before the VA loan is paid off, the buyer can assume the remaining mortgage, even if he or she is not a servicemember. This is a great selling point when a house is on the market.

Refinancing Options

There are two types of VA loan refinancing options. The cash-out refinance option allows you to finance up to 90% of the value of the home and, if you qualify, obtain extra cash while doing so. The Interest Rate Reduction Refinance Loan – the VA IRRRL – can reduce your interest rate via a streamlined process that does not require an appraisal.

What Are the Cons of a VA Loan?

No loan is perfect, so even while there are several benefits to a VA loan, there are other considerations that must be kept in mind. Here’s a look at the main drawbacks of a VA loan.

VA Funding Fee

Those who take advantage of the VA loan must pay the VA funding fee — a mandatory fee charged by the VA to help keep the program running for future generations. The good news is that this fee can be rolled into the mortgage, which reduces the out-of-pocket expense when buying a home. Those with a service-related disability, a Purple Heart, or spouses of deceased servicemembers are exempt from paying the fee. Here is what the funding fee will cost, with data provided by the VA web site:

Source: Veterans Administration

Property Restrictions

VA loans are meant to help people afford a residence. They cannot be used for a rental property unless the owner lives in one of the units. Manufactured homes have strict requirements and require assessment by a structural engineer.

Can Only Be Used for Primary Residences

Because VA loans are meant to provide servicemembers a primary home, they cannot be used for investment properties or vacation homes. Typically, owners must reside in the property within 60 days of closing.

Alternatives to VA Loans

Clearly VA loans have positives, but they may not be for everyone. Here are alternatives to VA loans, all of which are available to servicemembers:

• Conventional loan: A conventional loan is type most borrowers use. It is provided by banks, credit unions and mortgage lenders. Terms typically are 30 years, and these loans can be used for rental properties. Interest rates will be a little higher, and those who put down less than 20% will have to pay PMI.
• FHA loan: A Federal Housing Authority (FHA) loan is insured by the federal government and provided by FHA-approved banks or agencies. Because these loans are designed to help low-to-moderate-income borrowers, the borrower may be able to make a lower down payment. However, FHA loans require borrowers pay an annual mortgage insurance premium and PMI. Interest rates also will be higher.
• USDA loan: A U.S. Department of Agriculture (USDA) loan is only for those who live in designated rural areas. These loans have income requirements, and the property has to be a single-family home. Only 30-year fixed rate mortgages are available, but those who qualify may be able to buy the home without a down payment.

Is a VA Loan a Good Option?

Servicemembers who have a good credit score and are looking to buy a home would be wise to start by investigating the VA loan. Its many attractive financial benefits – no down payment, favorable terms, etc. – offset concerns about the loan. These loans helped an entire generation afford housing after World War II and still offer benefits to present-day veterans.

However, it also is wise to carefully study whether the VA loan is the best option for you. Each situation is different, and the funding fee is expensive (even when rolled into the principal). One assessment from Bankrate offered this rule of thumb: The VA funding fee is not worth it if you do not stay in your home for two years or less.

If debt is an issue or concern, it would be wise to speak with a nonprofit credit counselor who can assess your situation and offer possible solutions. Credit counseling could help assess whether a VA loan is the right loan for your situation.