This is the first in a series on mortgage programs for veterans. This article explores the U.S. Department of Veterans Affairs (VA)-guaranteed mortgage.
For a comparison of VA, Federal Housing Administration (FHA) and conventional mortgages, see Part II of this article series.
VA mortgage availability
A former member of the armed services – a veteran – is interested in purchasing a home. The veteran’s income and credit rating are sufficient to qualify them for a home mortgage. However, the veteran has not accumulated enough money for the down payment required by conventional lenders and issuers of private mortgage insurance (PMI).
May the veteran buy a home now, even though their savings are insufficient for a typical down payment?
Yes! The U.S. Department of Veterans Affairs (VA) mortgage guarantee program is specially designed to assist qualified veterans to buy a home with zero down payment.
To be eligible for the VA-guaranteed mortgage program, the veteran homebuyer needs to have:
- served at least 90 days on active duty during World War II, the Korean Conflict, the Vietnam era, or the Persian Gulf War;
- been discharged or released from active duty for a service-connected disability after September 15, 1940; or
- served on active duty for more than 180 days, after July 25, 1947. [38 United States Code §3702(a)(2)]
Reservists who have completed a total of six years in the Selected Reserves or National Guard are also eligible if:
- they are a member of an active unit, attended required weekend drills and two-week active duty for training; AND
- were discharged with an honorable discharge;
- were placed on the retired list;
- were transferred to the Standby Reserve or an element of the Ready Reserve other than the Selected Reserve after service characterized as honorable service; or
- continue to serve in the Selected Reserves. [38 USC §3701(b)(5)]
Individuals who completed less than six years may be eligible if discharged for a service-connected disability.
Others eligible for the VA mortgage guaranty program include:
- the surviving spouses of veterans who died from service-related injuries; and
- spouses of service members who are listed as missing in action or have been prisoners of war for more than 90 days. [38 USC §3701(b)]
An honorable discharge certificate is the veteran’s certificate of eligibility for the program. A veteran without a discharge certificate, or whose discharge was other than honorable, may apply to the Secretary of the VA for a certificate of eligibility. [38 USC §3702(c)]
Mortgages guaranteed by the VA are limited to mortgages which fund the financing of the veteran’s residence, including:
- the purchase or construction of residential improvements consisting of one-to-four units;
- the purchase of a farm with an existing residence;
- the construction of a residence on a farm owned by the veteran;
- the purchase of a single family residence (SFR) unit in a condominium project;
- the purchase of a manufactured home which is permanently affixed to a lot, or which is to be affixed to a lot owned by the veteran;
- the additional improvements to an existing residence;
- the installation of energy-efficient improvements on an existing residence; or
- the refinance of an existing VA mortgage. [38 USC §3710(a)]
The VA will only guarantee mortgages which are a first trust deed lien on the property, except for home improvement mortgages which may be a second trust deed lien. [38 USC §3703(d)(3)]
Further, VA-guaranteed mortgages are only made on property to be occupied by the veteran or their spouse as their primary residence, or for veterans currently on active duty. [38 USC §3704(c)]
The lender’s VA mortgage guaranty
A VA-guaranteed mortgage is originated and funded by an institutional lender or mortgage banker. The VA merely guarantees payment of a portion of the mortgage if the veteran defaults and the lender suffers a loss on the mortgage.
The amount guaranteed by the VA varies according to the amount of the mortgage as follows:
- for a mortgage of $45,000 or less, 50% of the mortgage;
- for a mortgage over $45,000 and up to $56,250, $22,500;
- for a mortgage over $56,250 and up to $144,000, 40% of the mortgage, limited to $36,000; and
- for mortgages exceeding $144,000, the lesser of 25% of the mortgage amount and 25% of the applicable Freddie Mac conforming mortgage limit for an SFR. [38 USC §3703(a)(1)(A)]
The VA-guaranteed portion of the mortgage varies over the life of the mortgage based on the outstanding mortgage amount.
For example, a veteran borrows $250,000. The Freddie Mac mortgage limit is $417,000. Thus, on origination, the VA-guaranteed repayment is 25% of the mortgage amount, or $62,500. Over time, the veteran makes mortgage payments and the outstanding mortgage balance decreases. Years later, the mortgage balance is $200,000. The VA guaranty now is only $50,000, being 25% of the $200,000 remaining balance. [38 USC §3703(b)]
Guaranty limited to entitlement
The portion of a mortgage guaranteed by the VA is the amount of the guaranty entitlement the veteran homebuyer is eligible to receive from the VA.
The maximum dollar amount of entitlement per veteran applies to all VA-guaranteed mortgages made to the same veteran.
For example, a veteran borrows $10,000 on a VA-guaranteed mortgage. The VA guarantees 50% of the mortgage, or $5,000. The veteran still has $31,000 of guaranty entitlement left which they may apply toward future VA-guaranteed mortgages of less than $144,000.
The maximum guaranty entitlement available to each veteran has increased several times since the inception of the VA mortgage guaranty program. With each increase, a veteran who previously obtained a VA-guaranteed mortgage receives an additional guaranty entitlement.
Additionally, if two or more individuals (such as spouses) are each eligible veterans, they may combine their guaranty entitlements to qualify for a larger mortgage on one-to-four unit residential property. However, the property needs to be the primary residence of both veterans. [38 Code of Federal Regulations §36.4308(b)]
Reinstatement of eligibility
Even though a veteran may have used their maximum guaranty entitlement to obtain a VA-guaranteed mortgage, they may obtain another VA-guaranteed mortgage in the future.
However, before another mortgage is guaranteed by the VA for the maximum entitlement, the veteran’s guaranty entitlement needs to be restored through a process called reinstatement of eligibility.
Reinstatement of eligibility occurs when the veteran disposes of the property and:
- the previously guaranteed mortgage is paid in full;
- the VA is reimbursed for amounts it paid to a lender for losses on a guaranteed mortgage originated by the veteran; or
- another veteran assumes the VA-guaranteed mortgage and replaces the guaranty entitlement with their own entitlement. [38 USC §3702(b)]
Consider a veteran who bought a house in the early 1970s, and used their maximum guaranty entitlement of $12,500. The maximum guaranty entitlement now available has increased since the early 1970s to $36,000. Thus, the veteran has $23,500 left in entitlement eligibility they may use for future home mortgages of less than $144,000.
If the veteran’s eligibility has been fully reinstated by the veteran paying off the mortgage, the veteran has the full entitlement available to them — up to the lesser of 25% of the mortgage amount and 25% of the applicable Freddie Mac conforming mortgage limit for a single family residence, for a mortgage amount exceeding $144,000.
VA automatics and income and credit requirements
Financial institutions subject to governmental supervision and mortgage bankers in compliance with VA lender guidelines are allowed to certify mortgages conforming to VA regulations, called VA automatics.
These lenders are allowed to issue certificates of reasonable value (CRVs) which set the maximum mortgage amount and the value of the real estate securing the mortgage, collect fees and deposits and certify the real estate meets the VA’s requirements. Use of a VA automatic lender greatly speeds up the process of obtaining a VA-guaranteed mortgage.
The VA has set credit history standards and income criteria veterans meet to qualify for a VA-guaranteed mortgage.
In determining a veteran’s ability to pay – creditworthiness – the VA uses two income criteria:
- debt-to-income ratio (DTI); and
- residual income, defined as the income remaining to cover family living expenses (e.g. food, gasoline) after subtracting monthly shelter expense. [VA Pamphlet 26-7 Chapter 4.9.e]
To qualify for a VA-guaranteed mortgage, the veteran who does not possess compensating factors needs to meet the income guidelines of:
- a debt-to-income ratio of less than 41%; [41% VA Pamphlet 26-7 Chapter 4.10.b] and
- residual income greater than the guidelines, which vary based on region and family size;
- the VA’s minimum requirements for estimated living expenses — for active duty veterans receiving the benefits of living near a base, the minimum residual income requirement is reduced by 5%. [VA Pamphlet 26-7 Chapter 4.9.e]
The debt-to-income ratio is determined by comparing the veteran’s total monthly obligations for housing expenses and any long-term debt to their gross monthly income.
Residual income is an entirely different analysis of gross income from conventional mortgage lending. It is determined by subtracting the veteran’s monthly obligations for estimated income taxes, shelter and other debts from their gross monthly income. The purpose of a residual income review is to ensure the veteran is able to meet minimum living expenses set by the VA residual income guidelines. [VA Pamphlet 26-7 Chapter 4.9.e]
Positive compensating factors possessed by the veteran are considered if their residual income is below VA guidelines or their debt-to-income ratio is above 41%. Positive compensating factors include:
- significant residual income;
- conservative use of consumer credit;
- long-term employment;
- significant liquid assets;
- a large down payment;
- little to no increase in living expenses due to the purchase;
- military benefits; and
- tax benefits of homeownership. [See first tuesday Form 320-4; VA Pamphlet 26-7 Chapter 4.10.d]
Veterans who fail to meet one of the credit requirements are not automatically prohibited from obtaining a VA-guaranteed mortgage. The VA does not limit its creditworthiness evaluation to the published guidelines. Special circumstances may exist which cause the VA to approve a mortgage to a veteran who does not otherwise qualify. [38 USC §3710(g)(5)]
For instance, a veteran may use their VA entitlement to purchase income-producing property consisting of two-to-four residential units if the veteran occupies one of the units as their primary residence.
If income from the rental units is used as a source of revenue to carry payments on the VA-guaranteed mortgage, the veteran needs to demonstrate to the VA that they possess the management skills needed to be a successful landlord.
Also, a cash reserve needs to exist to cover the payments on the mortgage for up to six months without any rental income.
The VA mortgage guaranty program was established to encourage lenders to make home mortgages to veterans. However, the VA mortgage guaranty program provides no assurance that all veterans will qualify for a mortgage.
Mortgages eligible for guaranty
The three basic categories of mortgages which qualify for a VA mortgage guaranty are:
- fixed rate home mortgages;
- adjustable rate mortgages (ARMs); and
- graduated payment mortgages (GPMs).
The VA imposes separate restrictions on each type of mortgage offered. For fixed rate mortgages, the VA requires:
- a term of no more than 30 years and 32 days;
- full amortization if the mortgage term exceeds five years; and
- an interest rate mutually agreed to by both the lender and the veteran homebuyer. [38 USC §3703(c), (d)]
For an ARM to be eligible for a VA guaranty, the mortgage adjustment provisions needs to:
- correspond to a specified national interest rate;
- provide for the monthly payments to be adjusted annually on the anniversary of the mortgage’s closing;
- limit interest rate adjustments up or down to one percent per year; and
- establish a life-of-mortgage interest rate cap not to exceed the initial (teaser) interest rate on origination by more than five percentage points. [38 USC §3707(b)]
Further, the VA requires the lender to fully explain the features of the ARM to the veteran homebuyer. Disclosures include a hypothetical payment schedule showing the maximum potential payment increases for the first five years of the mortgage term. [38 USC §3707(d)]
GPMs are also eligible to be VA-guaranteed mortgages, provided:
- the period of deferred interest, called negative amortization, does not exceed five years;
- the total amount of outstanding principal and interest owed on the mortgage will never exceed the value of the property at the time of origination;
- the monthly payments are increased annually on the mortgage’s anniversary date;
- the increase in monthly payments is limited to 7.5% annually; and
- the payments made after the five-year deferred interest period are approximately equal and are sufficient to fully amortize the mortgage over the term remaining on the mortgage. [38 CFR §36.4310(e)]
A GPM will allow a veteran homebuyer to qualify for a larger mortgage than available under a fixed rate mortgage.
Special VA mortgage regulations
The lender’s processing of a VA-guaranteed mortgage application is accompanied by procedures and requirements regarding:
- property standards;
- structural warranties; and
- mortgage funding fees.
Like all mortgage insurers, the VA requires an appraisal of the real estate securing the VA-guaranteed mortgage. The appraisal is prepared and submitted by an appraiser who meets the VA’s criteria. Generally, the VA will approve an appraiser who has at least five years of appraisal experience. [38 CFR §36.4342]
The VA, on receipt of a copy of the appraisal, determines and sets what it believes to be a reasonable value of the property. The VA prepares and sends a CRV to the lender. VA automatic lenders may issue a CRV without sending the appraisal to the VA. [38 USC §3731]
The veteran may agree to pay a purchase price which exceeds the reasonable value set by the VA. However, the VA will only guaranty financing based on the findings of the CRV. The excess in the actual purchase price over the CRV is paid by the veteran or financed separately.
Conversely, the veteran will not be required to make a down payment if the CRV is greater than the agreed to purchase price, since the VA lender will finance an amount equal to the CRV. [38 USC §3710(b)(5)]
The property which will secure the VA-guaranteed mortgage needs to meet minimum VA eligibility property standards.
Property securing a home construction mortgage, or a home constructed within one year before recording the veteran’s guaranteed mortgage, needs to meet minimum property requirements for planning, construction and general acceptability prescribed by the VA. [38 USC §3704(a)]
Further, a residence constructed after the enactment of the energy efficiency standards in 1992 needs to comply with the VA standards to qualify for a guaranty. [38 USC §3704(f)]
For construction mortgages, the builder, seller or another person designated by the VA needs to warrant the construction will conform to the specifications submitted to the VA for valuation of the property. The construction warranty also protects the veteran homebuyer if the condition of the improvements is misrepresented. [38 USC §3705(a)]
The VA is paid a mortgage funding fee when the VA issues a guaranty. The amount of the funding fee depends on the amount of down payment made by the veteran, the type of military service performed by the veteran and the purpose of the mortgage.
The funding fee, sometimes called a guaranty fee, may be added to the mortgage balance. However, all other closing costs are paid as out-of-pocket expenses of the veteran homebuyer, or paid by the seller. [38 CFR §36.4313]
For a veteran or reservist using their VA entitlement on a purchase-assist or construction mortgage, the funding fees are:
For cash-out refinances, the following funding fees are charged:
A fee of only 0.5% is charged on a no-cash-out refinance which pays off an existing mortgage (VA-guaranteed or conventional) when the refinancing is sought to reduce the interest rate on an existing mortgage. [38 USC §3729(b); VA Pamphlet 26-7 Chapter 8.8.h]
If the mortgage assists in the purchase of a manufactured home, the funding fee is limited to 1% of the mortgage for all veteran homebuyers. [38 USC §3729(b)(2)(G)]
A fee of 0.5% applies to mortgage assumptions.
Veterans who receive compensation from the VA for a service-connected disability are exempt from paying a funding fee. Also, a surviving spouse of a veteran who died while on active duty from a service-connected incident is exempt from paying a funding fee. [38 USC §3729(c)]
These fees are in place through September 30, 2017.
The VA applies somewhat different regulations on mortgages secured by manufactured homes. The VA only guarantees 40%, but not more than $20,000, of a mortgage used to purchase a manufactured home.
Any entitlement previously used by the veteran and not reinstated is subtracted from the $20,000 maximum.
The term of a mortgage used to purchase a manufactured home is limited to:
- 15 years and 32 days, for a mortgage to purchase a lot;
- 20 years and 32 days, for a mortgage to purchase a single-wide manufactured home or a single-wide manufactured home and a lot;
- 23 years and 32 days, for a mortgage to purchase a double-wide manufactured home; or
- 25 years and 32 days, for a mortgage to purchase a double-wide manufactured home and a lot. [38 USC §3712(d)(1)]
The manufacturer of the manufactured home warrants the condition of a manufactured home used to secure a VA mortgage. [38 USC §3712(i)]
Direct mortgages to veterans in rural areas
The VA recognizes the difficulty a veteran may encounter in some rural areas locating a lender who is willing to cooperate in the origination of a VA-guaranteed mortgage. As a remedy, the VA will fund mortgages directly to veterans to purchase or improve a residence located in a rural area. Mortgages directly funded to veterans by the VA are subject to the same requirements as other VA-guaranteed mortgages, plus additional direct mortgage conditions. [38 USC §3711(a)]
To qualify for a direct mortgage, the veteran needs to first show the VA they are unable to obtain:
- financing at an interest rate which does not exceed the rate authorized by the VA; or
- a mortgage from the Secretary of Agriculture. [38 USC §3711(c)]
The maximum amount of a direct mortgage to a veteran is $33,000. Veterans who qualify for the full $36,000 VA-guaranty entitlement may borrow up to the $33,000 maximum through this program.
Veterans whose available guaranty entitlement is less than $36,000 may borrow a mortgage amount which bears the same ratio to $33,000 as the amount of the veteran’s remaining guaranty bears to $36,000. This amount is further limited to a maximum of 91.67% of their remaining VA mortgage entitlement. [38 CFR §36.4503(a)]
For example, suppose a veteran interested in a direct mortgage is currently eligible for $18,000 of guaranty entitlement. The veteran compares their guaranty entitlement to the $36,000 maximum figure and discovers that their entitlement is 50% of the maximum. Here, they are eligible for a direct mortgage of 50% of $33,000, or $16,500.
Direct mortgages to veterans carry an interest rate of 7.5%. However, if the mortgage is used to fund home improvements, the interest rate is 9%. [38 CFR §36.4503(a)]
The veteran homebuyer is charged a funding fee of $50 or 1% of the mortgage amount, whichever figure is greater. The funding fee is 2% of the mortgage amount if the mortgage requires progress disbursements, as is the case with a construction mortgage. [38 CFR §36.4504(b)(1)]
Closing costs incurred by the veteran homebuyer, including VA fees, insurance, recording fees, taxes, etc., are paid in cash as out-of-pocket expenses of the veteran or seller, not from the proceeds of the direct mortgage. [38 CFR §36.4504(b)(3)]
The term of a direct mortgage may not exceed 25 years and 32 days. However, the VA may extend the term for up to five years if necessary to prevent a default on the mortgage. [38 CFR §§36.4505(a), 36.4506]
A direct mortgage to a veteran is not assumable without the written consent of the VA. If the VA consents, the assuming party is subject to the same assumption fees and costs imposed on the assumption of a VA-guaranteed mortgage. [38 CFR §36.4508]
To compare the benefits of VA, FHA and conventional mortgages, see Part II of this article series.