California is home to over 160,000 active duty military members, and many more veterans.
The U.S. Department of Veterans Affairs (VA) guarantees mortgages for qualified veterans. Most VA-guaranteed mortgages are issued for purchasing a residence, and while construction mortgages are also eligible for the VA’s guaranty, few lenders offer this option.
The VA received feedback their previous guidance for construction mortgages left too many questions unanswered. As an unintended result, many lenders have chosen not to issue VA construction mortgages.
These clarifications on the lender’s process of closing a VA-guaranteed construction mortgage are meant to shed some light on the rules, and encourage lenders to begin issuing more VA construction mortgages. These clarifications are active through April 1, 2020.
The lender’s process
The lender’s process for qualifying a borrower for a VA-guaranteed construction mortgage is similar to qualifying a borrower for a purchase-assist VA-guaranteed mortgage: it starts with verifying the veteran is eligible. [VA Circular 26-18-7 3.d(3)]
For underwriting, when a veteran does not plan to occupy the new home immediately after closing, the underwriter needs to consider the housing costs paid until occupancy of the new build. In most cases, the veteran will need a housing reserve to cover this extra cost. [VA Circular 26-18-7 5.g]
After verifying and qualifying the veteran, the lender needs to order an appraisal:
- “based on plans and specs” if the appraisal can be completed before the foundation is laid; or
- once construction is complete if construction has begun and the foundation has already been completed.
Next, the lender issues a Notice of Value (NOV) based on the results of the appraisal.
The lender needs to pay the funding fee within 15 days of closing. The lender needs to deliver the funding fee to the VA within 15 days of the mortgage closing, regardless of when construction commences or finishes. [VA Circular 26-18-7 5.e(4)]
In addition to the 1% mortgage origination charge, lenders may charge the veteran up to 2% of the construction mortgage amount for the lender’s services, as long as at least 51% of the mortgage proceeds are used during the construction phase. [VA Circular 26-18-7 5.e]
An escrow account needs to be established for disbursement of construction funds. It’s the lender’s responsibility to ensure escrow items are completed.
Acquisition costs may be included in the VA mortgage when evidence is submitted of:
- the contract to build;
- the interest reserve if not already included in the contract to build;
- the contingency reserve;
- permits if not included in the contract to build;
- and either:
- the lot’s value (if acquired more than one year from the VA mortgage’s closing);
- the cost of the lot (if acquired within one year from the VA mortgage’s closing); or
- the lot’s value minus any liens on the property (if gifted to the veteran).
The maximum mortgage amount equals the lesser of:
- the VA’s NOV; or
- the acquisition costs plus the costs of any energy efficiency improvements (up to $6,000), plus the VA funding fee. [VA Circular 26-18-7 5.l]
When change orders are issued to the plans and specs, the veteran can either pay for the changes out of pocket or pay for a new appraisal to see how the changes impact the home’s value and mortgage amount.
Builders and inspectors
Allowable builders are registered builders with the VA. It’s the lender’s responsibility to verify the builder meets their state’s licensing standards.
The builder is responsible for:
- interest payments during construction (if not included in the interest reserve); and
- all fees normally paid by the builder, including:
- inspection fees;
- commitment fees;
- title update fees; and
- hazard insurance during construction.
Once the mortgage is closed and construction is finished, a final inspection needs to be conducted — unless a Certificate of Occupancy is already issued by the local government. Further, if the local governing authority performs an inspection but does not issue of Certificate of Occupancy, the VA will accept:
- copies of the inspection reports that verify local building codes are met; or
- a written statement from the local governing authority that the inspections were conducted and the building is satisfactory. [VA Circular 26-18-7 5.h]
If the local authority does not conduct a final inspection, the property needs to be covered by a 10-year insured protection plan accepted by the Department of Housing and Urban Development (HUD) plus a one-year VA builder’s warranty. [VA Circular 26-18-7 5.h(1)(c)]
Next, the lender modifies the mortgage based on final construction costs.
If construction is not completed, resulting in the partial disbursement of funds, the VA guaranty extends only to the lesser of:
- 80% of the value of the completed construction, plus any disbursements used to purchase the lot; or
- the total mortgage proceeds disbursed for construction, plus any disbursements made to the builder by or on behalf of the VA.
Finally, the lender guarantees the mortgage as a purchase-assist VA-guaranteed mortgage.