The term "VA loan" refers to loans guaranteed by the Department of Veteran Affairs (VA) that are available to eligible veterans and their spouses.
Eligibility extends to the spouse of a service member who has died due to service-related conditions or who is missing in action or a prisoner of war, provided the spouse has not remarried.
History of the VA Loan
The Servicemen's Readjustment Act was passed in 1944 by the United States Congress.
This act offered various benefits to eligible veterans, particularly the VA loan guarantee program.
The VA is authorized to guarantee or insure home, farm, and business loans for veterans by lending institutions.
Over 20 million VA home loans have been insured by the government throughout the program’s history.
Expansion of Eligibility
Before 1992, VA loans were available only to veterans who served on active duty within specified periods.
The Veterans Home Loan Program Amendments of 1992 expanded eligibility to reservists and National Guard personnel who served honorably for at least six years, even if they did not meet previous active duty requirements.
Reservists and National Guard members must pay a higher funding fee when obtaining a VA home loan.
Understanding Loan Guarantees
A loan guarantee is a promise by the guarantor (VA) to assume the debt obligation of a borrower in case of default.
Guarantees can be limited or unlimited, with the guarantor liable for part or all of the debt.
VA loans involve a limited guarantee referred to as entitlement.
VA Loan Basics
VA loans can be utilized for various purposes:
Owner-occupied houses or condominiums
Improvements
Manufactured homes
Land
Farms
Refinancing or assuming existing VA loans
VA loans cannot be used for investment properties.
Typically, there is no required down payment for VA loans.
Eligibility Criteria
Veterans must qualify based on their debt-to-income ratio, which should not exceed 41%.
To qualify for a VA loan, veterans must meet established time and service criteria.
VA does not lend money; it only guarantees loans made by qualified lending institutions.
Maximum Loan and Guarantee
The VA guarantees the first 25% of the loan to ensure that low or no down payment loans remain acceptable to lenders.
This means that if a borrower defaults immediately after a no down payment, the lender is protected for 25% of the loan amount.
There is no limit on the actual loan amount.
The maximum guarantee is determined by the lender, with the VA's limit based on its guarantee upon default.
VA Eligibility Requirements
To access VA loan benefits, an individual must apply for a certificate of eligibility.
This certificate indicates whether a veteran qualifies for VA loan benefits, but does not guarantee that a loan will be approved.
VA Entitlement
Entitlement is the amount the VA guarantees to pay back in case of borrower default.
Each veteran is entitled to a basic entitlement of at least $36,000, provided they meet service requirements.
The specific amount guaranteed depends on the loan amount and any prior use of entitlement.
Remaining Entitlement
Veterans who have previously used a VA loan may still retain entitlement for subsequent loans.
Remaining entitlement is the difference between the maximum entitlement amount and the amount previously used.
The maximum entitlement amount is $113,275.
For example, if a veteran used $50,000 of their entitlement, they retain $63,275 in remaining entitlement.
Lender Requirements
Most lenders need a combination of guarantee entitlement and any cash down payment to equal at least 25% of either the reasonable value or sales price of the property, whichever is lower.
Entitlement Math
Despite a basic entitlement of $36,000 appearing to allow for a maximum loan of $144,000 ($36,000 divided by 25%), the VA links its guarantee limits with the FHFA conforming loan limits.
The current conforming loan limit is set at $548,250.
Therefore, 25% of this limit amounts to $137,062.50, which is the maximum guarantee amount.
Secondary Entitlement Amount
Secondary entitlement is calculated by subtracting the basic entitlement from the maximum guarantee amount.
137,062.50−36,000=101,062.50.
In regions with higher cost of living, where conforming amounts are beyond $484,350, the VA guarantee limits are adjusted accordingly.
Scenario: Susan's Entitlement
Example: Susan is a veteran with full entitlement purchasing a home for $300,000 (the conforming loan limit is $484,350).
Maximum guarantee = 484,350imes0.25=121,087.50.
Loan amount guarantee = 300,000imes0.25=75,000.
VA guarantees $75,000 on Susan's $300,000 loan because it is the lesser of the two.
VA Loan Qualification
The two methods used to determine a veteran's qualification for a loan are:
Debt to income ratio
Residual income
Debt to Income Ratio
Combined total monthly debts must not exceed 41% of the veteran's gross monthly income.
Considered debts include house payment, installment accounts, revolving accounts, child support, and childcare expenses.
Residual Income
Residual income is defined as the monthly income left after all debts, income taxes, Social Security tax, maintenance, and utility expenses are deducted.
A regional chart for residual income based on family size and loan amounts is available from local lenders.
VA Loan Funding Fees
All VA loans carry a funding fee, which is separate from the lender's origination fee and can be financed into the loan amount.
These fees cover costs for the VA loan guarantee program.
Fees are waived for veterans with disabilities and for surviving spouses of those killed in action or prisoners of war.
The funding fee is:
2.15% for the first VA loan with no down payment.
3.3% for a second VA loan.
The fee is reduced for higher down payments.
National Guard members and special reservists typically pay a higher fee compared to active service veterans.