For those home buyers seeking to come to the settlement table with as little cash as possible, the VA loan is perhaps the very best choice for those who qualify. Why? The most popular feature of a VA loan is the lack of a required down payment. Eligible borrowers can certainly make a down payment on a VA loan but there is no reason to, especially if coming to the closing table with as little money as possible is a goal.
VA also limits the types of closing costs veterans are allowed to pay, further decreasing necessary cash to close. VA loans also carry an inherent loan guarantee. The guarantee doesn’t apply to the borrower, they still have to qualify based upon credit, income, assets and employment, but the guarantee does apply to the lender. Should the loan go into default, the lender is compensated at 25% of the loss due to foreclosure.
This guarantee isn’t free but is financed by what is referred to as the Funding Fee which is currently 2.3% of the sales price for first-time use and no down payment. This fee can change based on borrower status and the presence of a down payment. For example, for someone buying their first home and using the VA loan for the first time and making a 10% down payment is 1.4% instead of 2.3% of the sales price. If someone uses a VA loan for the second time and no down payment the funding fee rises from 2.3% to 3.6% of the value. These amounts are reserved for veterans and active-duty personnel.
For example, a first-time buyer and qualifying service member using a VA loan to finance a home will pay 2.3% of the sales price on a home under contract for $250,000. The funding fee is then $5,750 yet is not paid for out of pocket and instead rolled into the loan amount for a final loan of $255,750. Remember, this is for a purchase. There is also a funding fee when refinancing.
When borrowers refinance from one VA loan into another VA loan, this is called an “Interest Rate Reduction Refinance Loan,” or IRRRL. Lenders usually refer to this transaction as a VA streamline due to the reduced amount of documentation required. With a streamline, the funding fee is reduced to 0.5% of the appraised value. If a homeowner wants to pull out cash during the refinance process (cash-out loan) the funding fees revert to the standard amounts. Only the streamline IRRRL program offers a 0.5% funding fee.
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Unlike the other two government-backed loans of FHA and USDA, the VA loan does not require an annual mortgage insurance premium paid in monthly installments. This keeps the monthly payment lower due to the absence of a monthly funding fee payment.
The funding fee may also be considered a form of mortgage insurance. Yet it’s not the type of mortgage insurance that makes a mortgage payment on behalf of the borrowers should they no longer be able to, such mortgage insurance doesn’t exist. The mortgage insurance policy financed by the funding fee is actually in favor of the lender. The borrower pays for it by rolling it into the loan amount but should the loan go into default and the lender is forced to foreclose, the lender compensated at 25% of the loss.
Homebuyers that have questions or want to learn more about VA loans can visit VA Mortgage Hub