Trying to buy a house and figure out how much you can afford isn’t easy when you’re employed in the private sector, but if you’re in the military (or are a veteran), then there’s yet another piece to your personal homebuying puzzle: Do you know how to get a VA loan? Do you know if you want one?
The good news is that most people who are eligible for a VA loan can afford more than with a conventional loan; the bad news is that you won’t know how much you can afford and whether it’s your best bet until you dig under the hood and learn a little bit more about what they are and how they work — or how to get one.
A VA loan is a mortgage backed by the U.S. Department of Veterans Affairs that is designed to help veterans, service members, and their surviving spouses become homeowners. Private lenders issue the loans, and the VA guarantees a portion of the loaned amount.
Lenders can offer better terms with VA backing, and these loans give borrowers several advantages compared to other loans. One of the biggest is freedom to refrain from making a down payment — at all. VA borrowers can also avoid mortgage insurance. And they benefit from lower-than-average mortgage interest rates.
Zero down, no mortgage insurance, and attractive rates mean that a VA borrower can often qualify to borrow more money through the program than through another program, such as a conventional loan or an FHA loan. So how do you get a VA loan?
The history of VA loans
The VA loan program dates to 1944, when the GI Bill of Rights — officially known as the Servicemen’s Readjustment Act — was signed into law. In fiscal year 2019, according to the VA, 624,546 loans were made under the program. The average loan amount was $281,226, and the total loan amount reached $175.6 billion.
VA loans can be made for several purposes, including:
- Purchasing a home
- Building a home
- Refinancing an existing home loan
- Improving a home by installing energy conservation measures, such as solar heating
Requirements to get a VA loan
VA loans are only available to veterans, active-duty military service men and women, or their surviving spouses. Veterans also will have to meet requirements for length of service.
VA loan requirement comparisons
The down payment is the biggest obstacle to homeownership. But VA borrowers are lucky enough to skip this hurdle entirely, however, since they can put as little as 0% down. According to the VA, 90% of VA borrowers do just that.
The VA itself has no official minimum credit score for extending a mortgage loan, the private lenders who make the loans can and usually do impose minimum credit scores. Lenders may require VA borrowers to have credit scores of 620 or above.
The VA can also limit the size of the loan it will guarantee. If the requested loan amount would require a guarantee above the VA’s maximum amount, the borrower may have to make a larger down payment in order to bring the loan size down.
VA loan costs and fees
VA loans also typically offer lower costs and fees than other programs. This includes freedom from mortgage insurance and a cap on closing costs.
Combined, these can significantly expand affordability for VA borrowers.
Does a VA loan require mortgage insurance?
Under most loan programs, borrowers who put down less than 20% have to pay for mortgage insurance. This insurance protects lenders if the borrower defaults on the loan.
Mortgage insurance costs may range from 0.5% to 1% of the loan amount annually.
For a loan amount of $281,226 — the average for VA in 2019 — the mortgage insurance on another type of loan could be $2,812 a year. That would add $234 to the monthly payment, which could easily put the monthly payment outside the buyer’s range. But VA loan borrowers will have that much more to work with when they get ready to buy.
What’s the VA funding fee, and how much does it cost?
Although VA loans don’t require mortgage insurance, they do require borrowers who are buying or refinancing a home to pay a different, smaller fee. This VA funding fee can range from 1.25% to 3.5% of the loan amount.
The size of the fee depends in part on whether the borrower is using the VA loan benefit for the first time. Another factor is whether the borrower is making a down payment.
Like mortgage insurance, the VA funding fee is used to reduce the risk of a borrower failing to pay back the loan. However, unlike mortgage insurance, the VA funding fee is a one-time fee. It doesn’t include an annual premium, and it doesn’t have to be paid monthly.
The funding fee can be rolled into the loan. Because it increases the loan amount, this will have an effect on the monthly payment. But this effect is much smaller than mortgage insurance.
The VA will waive the funding fee for veterans who are getting disability pay. It will also waive the fee for surviving spouses.
VA closing costs
The VA has some limits on closing costs. It caps the lender’s origination fee at 1% of the loan, and it prohibits some fees altogether. Prohibited fees include real estate broker commissions, charges for follow-up appraisals, and attorney fees charged by the lender.
VA borrowers may still have to pay reasonable and customary fees for their initial appraisal, title insurance, credit report, and other allowable services. Altogether, VA closing costs are likely to be approximately 4% of the purchase price, with a range of 0.5% on either side. The actual percentage depends on various factors including the amount of pre-paid property taxes.
For example, assuming the 2019 average VA loan amount of $281,226 is the home purchase price, closing costs could range from between $9,843 and $12,655. The average would be about $11,249.
Home affordability and VA loans
The 28/36 rule is a shorthand approach to figuring affordability. It says a buyer should not spend more than 28% of their gross monthly income on all costs related to owning the home. Payments on debts including mortgage, auto loans, student loans, and credit cards also should not total more than 36% percent of gross monthly income.
Note that this isn’t how your lender will think about how much home you can afford, but we’ll get to that soon!
Another way to figure home affordability is to use a home affordability calculator. This free online tool uses six inputs:
- Gross annual pre-tax income
- Amount of personal savings
- Amount of savings used to pay down payment and closing costs
- Monthly debt payments not including housing
- Credit score
Using this information, the home affordability calculator will tell the user how much they can likely spend on a home.
Factors that affect how much home you can afford with a VA loan
The VA uses an additional guideline called residual income to estimate affordability. Residual income guidelines vary depending on the size of the borrower’s family and the geographic location.
Loan term is also a factor in determining affordability. That’s because the size of the monthly payments will be much smaller on, say, a 30-year loan than they will be on a 15-year loan.
The interest rate on the loan also matters. A higher interest rate increases the monthly payment, and that can reduce affordability.
Property taxes also affect affordability. Some areas have higher property taxes. Because these taxes are usually paid monthly with the mortgage payment, they can increase the payment.
Premiums on homeowner’s insurance required by lenders are also usually part of the payment. These premiums vary, but they average about $100 per month nationwide, according to PolicyGenius.
Homeowner’s association (HOA) fees are also included in housing costs, and they can vary wildly depending on the services your HOA provides.
Employment may also affect affordability. Lenders are looking for stable, long-term, full-time employment. Self-employed borrowers may need to provide two years of tax returns to verify employment.
What’s DTI, and why is it important to a VA loan?
The letters DTI stand for debt-to-income ratio, which is a percentage showing the ratio of a borrower’s total monthly debt payments to total monthly income. Lenders look at DTI to determine how much to lend.
Many lenders want to see a DTI ratio of 43% or less. However, depending on individual circumstances, an acceptable DTI figure may be higher or lower.
How to calculate your DTI
To calculate DTI, first add up all sources of income, such as wages, child support, and alimony. Then add up all monthly debt payments, including the anticipated mortgage payment, car loans, student loans, credit card minimum payments, and any payments of child support and alimony.
Divide your total debt payments by your total income to get DTI.
For example, consider a borrower earning $65,712, which the Census Bureau reports is the 2019 national median income. This means their gross monthly income is $5,476.
The borrower’s debts include a $400 car loan, $300 student loan, and $100 in credit card minimum payments.
We can assume that the monthly cost of the average VA loan of $281,226 is about $1,500, including principal, interest, taxes, insurance, and HOA fees.
Combining all debt payments produces a total of $2,300. Dividing this by $5,476 in income produces a DTI ratio of 42%.
This ratio is on the border of what is likely to be approved for a typical VA loan.
How to calculate your monthly housing budget using DTI
It’s possible to calculate the monthly housing budget needed to produce a certain DTI figure.
For example, to get a DTI of 30%, the above borrower would need a housing payment of just $800.
To get a DTI of 35%, the borrower could afford a mortgage payment of approximately $1,100.
Does military income count toward DTI on a VA loan?
The VA will consider wages and salaries, tips, commissions, rental income, and other income sources. However, not all types of military pay will be considered; disability pay from the military is not always considered income for a VA loan.
Military income that can be considered includes the Basic Allowance for Housing, flight pay, and hazard pay. Borrowers can also include pay from service in the National Guard and Reserves.
How can you lower your VA loan payments?
One way to reduce VA loan payments and make a house more affordable is to use a longer loan. The payment on a 30-year note will be significantly less than on a 15-year note.
Shopping around for a better mortgage interest rate is another way. Borrowers should check with three or more lenders to see who has the best deal.
Another way to boost affordability is to make a larger down payment. This will reduce the loan amount and the monthly payment.
Buying a more affordable home is another solution. If a buyer can’t qualify to borrow enough for one home, he or she can look for lower priced homes.
Are VA loans affordable? The pros and cons
VA loans have some major benefits, including:
- No required down payment
- No mortgage insurance
- Limitations on closing costs
- Better-than-average interest rates
- More flexibility on credit scores and other qualifying factors
A VA loan has no prepayment penalty if the borrower pays the loan off early, which is another benefit compared to some other loans. And borrowers who have previously declared bankruptcy can qualify for a VA loan sooner than they could with other loan programs.
Drawbacks of a VA loan for home affordability
There are also some limitations to VA loans, including:
- Eligibility is restricted to active service and military veterans and spouses
- They are not intended for investors, since borrowers must live in the house
- Zero down payment means little to no equity
- The VA funding fee affects closing costs
- Not all lenders offer VA loans, so rate shopping can be tougher
- Appraisal standards may be higher than for some loans
Costs on a VA loan compared to other loans
VA loans offer zero money down, no mortgage insurance, attractive interest rates and limits on the types of closing cost fees. These factors mean VA loans offer significant savings compared to other loans, including these popular loan types:
- Conventional loans require at least 3% percent down. Buyers who put down less than 20% will have to pay for mortgage insurance.
- FHA loans require at least 3.5% percent down. Buyers who put down less than 20% will pay for mortgage insurance.
- USDA loans also allow for zero down payments without mortgage insurance. However, USDA loans have stricter income requirements that make many borrowers ineligible.
All told, VA loans offer homebuyers who can meet the eligibility requirements a proven and practical way to increase the amount they can borrow and the house they can afford.
Header Image Source: (Chris King / Unsplash)