What is a VA Loan?

As someone in the Army, it feels like the Air Force doesn’t even belong to the military. Air Force training strikes me more as a luxury summer camp, and makes me question my life choices up to this point.

Military service has its perks, like 30 days of paid time off a year, free health insurance (don’t ask me anything about how normal health insurance works, I couldn’t tell you), and most importantly, that dining facility breakfast is chef’s kiss.

One of the biggest perks that all service members, Veterans, and their surviving spouses have access to is the VA loan. VA loans are home loans that are backed by the US Department of Veterans Affairs (hence the “VA”).

VA-backed home loans are offered by private lenders and are required to follow VA standards. These loans are backed by the VA, which means the VA will cover the losses to a lender if a home goes into  foreclosure and the value decreases below the outstanding loan amount. Since there’s less risk to the lender, they often offer service members more favorable terms than conventional home loans.

Let’s look at some of the core benefits and limitations of the VA loan.

No down payment required

Down payment requirements can be a significant barrier for people looking to purchase a home.

With traditional mortgages, you are typically required to place a down payment on the home you’re purchasing, normally ranging between 3.5% of the home’s value for FHA loans up to around 25% for some investment property mortgages. The down payment is a form of insurance for the lender. Except for a few crazy times, home values rarely go down beyond 20%. If you default on your loan, the lender has a very high chance of recovering all of the loan by reselling your house. If you haven’t put 20% down, the lender is at a higher risk of not recovering all of its loan.

After WWII, Veterans did not have the cash to buy a home. To help Veterans buy homes, the government passed the Servicemembers Readjustment Act to help solve this issue. With the VA loan, you aren’t required to make any down payment. You can borrow 100% of the money required to purchase a home. Lenders take this deal because the VA covers any principal loss (up to 25%) if the Veteran defaults. This eliminates the initial barrier to purchasing a home.

You can still make a down payment if you want. 

No private mortgage insurance

Private mortgage insurance (PMI) is an extra expense that conventional mortgage holders have to pay lenders each month. It typically applies to borrowers who put less than 20% down on a home. Conventional mortgage holders will pay PMI each month until you have 22% equity in the home (but you can request PMI cancellation when you reach 20%) or until you’re halfway through the term of your loan.

VA loans do not involve PMI. Instead, they require a funding fee. The funding fee is a one-time payment that you make when you close on the home. All who use the VA loan are required to pay the funding fee, with certain exceptions. The funding fee is a percentage of the amount of money you’re borrowing to purchase the home. The greater the down payment you make, the smaller the funding fee (check out rates here).

This fee can be rolled into your overall mortgage value if you choose, reducing the amount of money you pay at closing.

Competitive interest rates

Because VA loans require less risk for the lender (since they’re backed by Uncle Sam), lenders often offer lower interest rates for VA loans compared to conventional mortgages. Lower interest rates equal smaller mortgage payments.

It’s a lifetime benefit

The VA loan doesn’t expire, so eligible people can use it for as long as they live.

For all the perks associated with the VA loan, it also has its limitations.

It must be used for a personal residence, not an investment property

The biggest limitation to the VA loan is that it can only be used to buy a home you intend to live in for at least 12 months. This means you can’t use a VA loan for a home that you exclusively intend to use as a rental property.

However, this doesn’t mean you can’t house hack, living in a part of the home while renting out another part. It also doesn’t mean that you can’t live in the home for the required 12 months and then move out, making it an investment property. Whatever you do, make sure you’re following the terms of your VA loan to avoid doing something illegal.

It can be used multiple times, but the amount of money the VA will back before requiring a down payment is limited

There is no limit to how many times you can use the VA loan. The number of times you can use the VA loan is only limited by your VA loan entitlement. Each active VA loan that you have decreases your entitlement. Most mortgage brokers don’t even understand how VA entitlement works so here's a calculator that can show you how many times you can use the VA loan without having to make a down payment.

Basically, each Veteran is entitled a certain amount of money in covered down payments. Every time you take a VA loan, even though the VA isn’t paying the down payment, it is on the hook if you default, so some of your entitlement is already ‘used.’ If you sell your house, the entitlement comes back.

Call to Action

If you’re eligible for a VA loan, consider using it if you plan on purchasing a home. If you aren’t eligible, thank a Veteran for their service (just kidding, this makes most service members and Veterans feel awkward).

What We’re Reading/Listening To:

The Culture Code by Daniel Coyle. Coyle goes inside some of the world’s most successful organizations to determine what makes them tick and thrive. The book is not at all finance related, but its data-driven findings are interesting for those looking to join (or build) high-performing teams.

Debrief on Deck

Next week, Wilson is going to talk about annuities. Annuities are like pensions that you pay for yourself, kind of like buying your own Christmas gift.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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