VA loans provide veterans with numerous benefits. You do not need a down payment and there is a cap on how much a lender can charge in closing costs. Borrowers can even secure interest rates that rival any other loan program. As an added bonus, the VA loan has flexible underwriting guidelines. A benefit many veterans overlook, however, is the absence of mortgage insurance. Even if you save just $50 per month without the need to pay insurance, this adds up to $18,000 over the life of a 30-year loan.
The Rival Loans
Comparing VA loans to the other most common loans available today, you can see how the savings stack up:
- Conventional loans – Conventional loans require a 20 percent down payment to avoid mortgage insurance. On a $100,000 home, this means $20,000. Realistically, $20,000 takes a long time for most people to save. If you do not put $20,000 down, you have to pay PMI. The exact amount you pay depends on your LTV and personal qualifying factors. However, it could be several hundred dollars per month. You are on the hook for this payment until you reach below 80 percent of the value of the home. Depending on how much you borrow, this could take many years.
- FHA loans – Every borrower pays mortgage insurance with an FHA loan. The minimum down payment allowed equals 3.5 percent of the purchase price. On a $100,000 home, this means just $3,500. In exchange for the low down payment, you must pay upfront and annual mortgage insurance. You pay the upfront MI at the closing in cash or wrap it into your loan. You pay the annual MI as a part of your mortgage payment. At almost 1 percent of the loan amount, this means almost $100 each month added to a $100,000 mortgage.
What is Mortgage Insurance?
It helps to understand what mortgage insurance is and why some loans require it. This insurance helps protect lenders in the face of default. You do not receive any benefits from the insurance, but you must pay it on certain loan programs. The insurance policy guarantees the lender will not lose the entire amount if you default on the loan. You must carry the insurance on conventional loans until you have at least 20 percent equity in the home.
Lenders drop PMI at 80 percent because a person with more equity is less likely to default on their loan. Even if you were to default at that point, the lender has a better chance of recouping their investment. A home with little equity in it, however, would force the lender to take a loss. It is harder to get the full value for a foreclosed home. Worse yet, if the value of the home decreased, the borrower could be upside down on the loan. This means they owe more than the home is worth. The lender would take a serious loss in this situation.
Why VA Loans Do Not Require Mortgage Insurance
VA loans have a guarantee from the Department of Veterans Affairs. They guarantee the lender a portion of the loan, should the veteran default. This takes the place of standard mortgage insurance. Even though you do not have to put any money down to secure the loan, you still do not have to pay MI. The VA pays the lender in the event a borrower defaults. However, the default rate on VA loans is among the lowest of any loan program available today. This is mostly due to the diligent effort the VA puts into helping homeowners keep their homes. They have a variety of home retention offers they can extend to struggling borrowers to help them keep their homes.
The VA Funding Fee
There is a tiny catch with VA loans, though. Because you do not have to pay mortgage insurance, you have to fund the VA in a different way. Without the funds, the VA would not have a reserve account to guarantee VA loans. This is why borrowers pay a funding fee at the onset of the loan. The amount you pay depends on the amount you put down. You do not have to put any money down on a VA loan, but there is the option. The more you put down on the home, the lower your funding fee. In addition, your title in the military plays a role. Veterans and active duty military personnel pay a lower percentage than those in the National Guard or Reserves.
Borrowers pay the funding fee at the closing. Those who cannot pay it in cash at the closing can roll the fee into their loan. There are certain circumstances where the VA waives the funding fee, though. These include:
- Veterans harmed in the line of duty that suffer a permanent disability
- Retired veterans receiving retirement pay that were harmed in the line of duty
- Surviving spouses of veterans who lost their lives during active duty or as a result of an injury that occurred during active duty
Typically, borrowers falling under any of these categories are exempt from paying the funding fee altogether.
The VA loan is a very affordable option for those who served our country. You can purchase a home with very little cash out of your pocket. The lack of need for mortgage insurance or a down payment makes this possible. In some cases, the seller can even pay your closing costs. This further decreases the money you need to bring to the closing.
Overall, VA loans are easy to qualify for because they have flexible underwriting guidelines. The largest factor they consider is the amount of money you have left over at the end of the month. This is called your disposable income. The VA wants you to have a specific amount of money each month to cover your daily living expenses. If you overextend your monthly debts, it could be harder to secure a VA loan. Work on paying your debts down before applying for a VA loan for the best chance at securing a loan that requires no down payment and no mortgage insurance.