How a VA Loan Works: Explained

VA home loans offer qualified borrowers a path to homeownership or home refinancing that regular citizens wish they had. With such enviable features as no down payment, simpler documentation, and no mortgage insurance, it's no wonder a VA home loan is highly desirable.

Let's look at VA home loans from various angles and gain a better understanding of this important benefit of American military service, including:

• The biggest advantages of a VA loan
• Who qualifies for a VA loan
• How to refinance a VA loan
• Disadvantages of a VA loan

What Is a VA Loan?

A common misconception about VA home loans is that you're borrowing from the government. While the Department of Veterans Affairs does stand behind your home loan, the money comes from the same private lenders who service traditional mortgages (a VA-direct program for Native Americans is the exception).

With the VA backing your home loan, you are likely to get more favorable terms from lenders. After all, Uncle Sam is vouching for you. All other things being equal, a VA borrower gets a lower interest rate than someone else.

"The first thing to know is that the VA loan is by far the best loan on the planet," says San Francisco Bay Area mortgage professional Joe Parsons. "It requires no down payment, there is no mortgage insurance, and the rate is typically a bit lower than an equivalent conventional loan."

VA loans can be used to buy, build, repair, retain, or renovate a home for your own occupancy.

VA loans take the same time to process as regular loans.

Who Is Eligible for a VA Loan?

Lenders don't screen for veteran eligibility themselves. Instead, lenders rely on the VA's standards as laid out in the Certificate of Eligibility (COE). Requirements can be met by veterans, servicemembers on active duty, and National Guard and Reserve members. Surviving spouses can qualify too. This certificate is how you prove to lenders that you qualify for a VA-backed home loan.

Credit score requirements are looser for VA loans. Ordinary loans often require credit scores in the high 600s or low 700s. VA borrowers can have credit scores much lower.

Minimum Active-Duty Service Requirements

Understandably, you can't enlist on Monday and take out a VA loan on Tuesday. To qualify for a VA loan, you must have served a certain length of time.

Service members.

If you're a service member who has served at least 90 continuous days, you meet the minimum service requirement.

Veterans.

The minimum service requirement depends on the time period in which you served. For instance, veterans of the Gulf War era (starting Aug. 2, 1990) all the way up to the present day have a different minimum service requirement than people who served the decade prior. See detailed requirements by service period at VA.org.

Once your eligibility is confirmed.

While the Certificate of Eligibility assures all lenders that you qualify for a VA home loan, lenders may have additional requirements, such as minimum credit score and income. Here's where shopping around for your best VA loan lender can help you a lot because every lender might have different requirements. Some lenders are also more willing to negotiate than others.

Most lenders will charge an origination fee for a VA home loan, such as 2.15%. This fee, like many others, is often negotiable. The fee is typically added to the loan amount, so it doesn't come from the veteran's pocket.

Making a down payment will reduce the origination fee; the larger the down payment, the bigger the reduction. For example, putting 5% down could drop the fee to 1.5%, and putting 10% down could drop it to 1.25%.

Even with the origination fee, the total closing costs you pay for a VA home loan are likely to be less than you'd pay for a regular mortgage. This is because the VA caps closing costs, limiting how much lenders can charge borrowers.

The Many Advantages of a VA Home Loan

Ask most homeowners and they will tell you the biggest hurdle they had to overcome was saving enough for a down payment. With a VA home loan, millions of Americans have achieved homeownership without that burdensome requirement. The Department of Veterans Affairs says that 90% of Americans who purchase a home with a VA loan do so with zero down payment.

What's more, a VA loan eliminates the need for you to carry private mortgage insurance (PMI), which is insurance that borrowers carry to protect the lender in case of default. PMI is mandatory for every ordinary borrower who can't put down 20%. PMI typically runs between 0.30% and 1.15% of the loan amount, and you can skip it when you take out a VA loan.

No down payment and no mortgage insurance are two major ways a VA loan helps American veterans reach their goal of homeownership. Here are 10 advantages to taking out a VA loan.

Another benefit of a VA home loan is that shopping around for your best VA loan is as easy as shopping around for a standard mortgage, thanks to the industry-leading comparison search hub Lendgo. As you answer basic questions about your needs, you indicate that you are an active or former member of the military, and Lendgo's search technology discovers lenders with the most impressive quotes for you.

Can You Refinance a VA Loan?

Yes, a VA loan can be refinanced. Refinancing a VA loan involves replacing the original VA loan with an Interest Rate Reduction Refinance Loan. As with a regular home mortgage refinance, you may opt to leverage your increased equity to take some of the new loan amount in cash via a cash-out IRRRL.

Despite the unique name for refinancing a VA loan, the most popular reasons to refinance a VA loan mirror those of a regular home loan. Foremost, you might want to lower your payment by replacing your old VA loan with a new VA loan at a lower interest rate. Another reason might be that the original VA loan was an adjustable-rate mortgage (ARM) and you'd like to swap it for a fixed rate before the old rate can adjust upward.

The most recent final government statistics show that VA loans were issued to 746,091 people in fiscal year 2022, with most veterans using the money for home purchase.

• 55% used their VA loan to buy a home
• 17% were refinancing their VA loan
• 28% did a cash-out refinance

The ability to refinance a VA loan helped many veterans take advantage of the record-low interest rates we enjoyed last year and the year before. If you're a veteran, regardless of your reason for refinancing, make sure to get the best terms you can on the IRRRL because the program becomes more expensive with every subsequent refinance.

Does a VA Home Loan Affect My Choice of Houses?

So long as you will live in the house or condo, you can buy it with a VA loan. There are no restrictions on property type.

A VA loan is meant to help veterans purchase their primary residence, so it can't be used to acquire an investment property or a vacation home. On the other hand, you could buy property with a VA loan that's large enough for you to reside on as well as rent out. The key is that you must reside there most of the year.

Although you're open to look for any house or condominium, securing it in competition with other buyers might be harder. It's not logical, but it's human nature. Sellers might choose another buyer over a VA borrower merely because they are encouraged by a larger down payment.

Joe Parsons explains: "If a seller receives two offers that are identical in every respect except that one has a 20% down payment and the other has a 5% down payment, they will accept the offer with the higher down payment almost every time. They will receive the same amount of cash at close of escrow with either offer, but they believe—incorrectly—that the offer with the larger down payment has a better chance of getting approved by the lender."

Are There Disadvantages to a VA Loan?

There are two disadvantages to making a small down payment, but they are true for all kinds of home loans, not just VA loans.

First, sellers might choose another buyer over you based solely on the down payment, as mentioned above. (But equally true is the fact that some sellers would prefer to sell to a veteran.)

Second, the less money you put down, the more you have to borrow. If you borrow 100% of the appraised value of the home and roll in the funding fee, you could be at negative equity the first year or so.

Related
Pay closing costs now or roll them into the loan amount?

Another disadvantage of a VA loan is that the seller might make less money. "A VA loan usually costs the seller more money," says Atlanta real estate broker Jay H. Link. "The VA is very protective of its veterans and rightly so. Any veteran Realtor will tell you that a VA appraisal is the most stringent. Many sellers, if presented with multiple offers, will opt for an offer with FHA or conventional financing over a VA offer, just because it nets the seller more money. This is especially true in competitive markets (seller's markets)."

The best, for the best.

Some real estate agents believe (wrongly) that VA loans are more complicated and may try to persuade borrowers to choose a traditional mortgage or an FHA loan, both of which require mortgage insurance. If this happens to you, be firm. The VA loan is the best loan you can get, and you're entitled to it.

Takeaways

• VA borrowers generally qualify for lower interest rates and don't need higher credit scores.
• Key financial advantages of a VA loan are no down payment, no PMI, and capped closing costs.
• The VA certifies your eligibility, then you go with the lender of your choice.
• At Lendgo, comparing VA loan options is as easy (and important) as any other home loan.