Real estate buyers qualify for home loan benefits from the U.S. Department of Veterans Affairs if they’ve performed 181 consecutive days of active duty (90 consecutive days in wartime), or spent 6 years in the National Guard or Reserves. Surviving spouses of veterans who died in service, or from related causes, may also qualify. A knowledgeable lender can tell you if you qualify — and assist you in obtaining official confirmation, in the form of a VA Certificate of Eligibility (COE).
Here, we lay out the nuts and bolts of the process.
VA Entitlements: How Far Do They Go?
The U.S. government backs a VA loan with an entitlement of $36,000. The $36,000 isn’t all a vet can borrow. It just assures the bank that if a borrower can’t keep making payments on any loan up to $144,000, the government covers the bank’s losses up to $36,000.
If you have used or are currently using some of your entitlement, you may tap into your remaining entitlement to buy or refinance a house. It’s there for you to use, even if you’ve had a short sale or foreclosure.
Also, there’s no government limit on the amount you’re allowed to borrow to buy a house. So, is it true that veterans can now borrow unlimited amounts, with no money down?
Not really. It’s up to the bank. For loans amounting to more than $144,000, the government will only guarantee up to 25% of the total, so if you’re hoping to borrow 144K+, expect banks to be especially cautious. Expect, in other words, to put money down.
You also need to know the county VA loan limit where the house is. The 2021 loan limit in most places is $548,250. (For a few of the pricier counties, the cap can be up to $822,375.) Check this map to see the loan limit where you’re buying a house.
Overlays: How Lenders Cut Risk
Under today’s VA rules (since 2020), if you’ve never used the benefit on a previous purchase and you’re not using it presently, you can use your full VA loan entitlement. This is a vet-friendly improvement over prior rules, which expected vets to put 25% down for loans over the county limit. Now — at least in theory — vets have unlimited borrowing power, without having to put anything down on the house.
Lenders, though, curb their risk of loss in the case home buyers can’t pay their mortgages at some point down the road. This is why lenders establish their own credit score minimums and additional rules — these are known as overlays.
So, depending on the lender, the loan applicant’s minimum credit score might have to be in the 620 to 660 range. And yes, there will be a scale of down payment amounts required, depending on the borrower’s credit score. Most banks will allow buyers with scores of 700+ to purchase homes with just 10% down or less.
The point is, you’ll likely need money for a down payment. Buyers who put down significant payments at the start are assuring the bank that they have a strong vested interest in continuing to make payments when times get rough.
Safety Latch: The VA’s Residual Income Requirement
VA loans have a built-in safety mechanism, too, to guard against foreclosures. The VA sets a residual income minimum. That’s the general spending cash a person has left over after all key monthly debts are paid. The minimum you’ll need to show depends on where the home is, and the number of people in your household. This figure gets important when applicants have a high amount of debt in relation to total income.
The debt-to-income (DTI) ratio is the borrower’s monthly debt obligations (including what overall debt will look like if the VA loan is approved) in relation to monthly income. The VA does not allow this ratio to be above 41%. Loan applicants whose debt-to-income ratio is higher than 41% must have about 20% more than the minimum residual income.
The idea behind all this calculating? It’s meant to make sure the homeowner is in the position to keep repaying the loan — no matter what kind of curveballs life may throw.
If you need to reduce your DTI ratio, you’re looking at either creating new income streams or cutting down debt. Could your DTI or credit score use some attention? Check out our 5-Point Credit Repair Plan before starting your loan application.
Underwriting: How Debt and Credit History Is Assessed
When you call lenders, you’ll want to be able to tell them how much you’ll need to borrow, your job and income situation and monthly debts, what you have in your bank accounts and retirement funds, your home ownership history, and co-ownership or community property status of a life partner who will share the home, and any negative credit history.
What negative credit history can be problematic? Student loans, tax liens, federal debts and late payments over the last three years are the biggest issues, and they can be deal-breakers. So, if you can, pay them off before getting ready to buy a home. At least, get onto a repayment plan with the government.
VA lenders use an Automated Underwriting System (AUS) to put all the facts into, so they can accurately screen an applicant’s borrowing power. Certain kinds of credit history will mean the AUS simply rejects the applicant. In close calls, or in complicated situations, lenders do have the discretion to make human decisions. Bottom line? Lenders want to see a reasonable debt-to-income ratio, so they are convinced the mortgage can be repaid over the years to come.
Milestone: Obtaining the Pre-Approval Letter
Pre-approval tells you what you can borrow. It shows buyers you’re prepared to get to closing. Although it’s not a final loan decision, it’s guidance to take you to that final stage.
Pre-approval depends on sending a slew of documents to the loan officer: proof of identification, pay stubs, federal tax returns and W-2s for the last two years, 1099s or rental income, stimulus pay, financial account statements, social security income, proof of military service and disabilities (if any), and family care and support obligations.
The way to approach this is to show clear evidence of all sources of income (other than GI Bill income) that is reasonably likely to continue for several years ahead. Avoid making any job changes during this time. If you are compelled to change your employment status, let your loan officer know as far in advance as possible.
Another part of the equation here is your co-borrower, if you have one. For example, you might plan to borrow and own with your non-vet spouse. If so, your spouse must share the home with you.
Your spouse’s credit profile can boost your borrowing power. On the other side of the coin, lenders require a minimum credit score for your co-borrower, and they count your spouse’s debts as part of the loan application’s total debt.
What if your co-borrower is someone other than your spouse? Unless it’s a fellow vet who is also using a VA entitlement to borrow, then it’s a joint mortgage and ownership. Because the VA does not back the joint owner’s part of the loan if there’s a default on the mortgage, it’s riskier for the bank. Thus, buying jointly involves making a higher down payment on the house.
Important note: With a VA loan, you must be buying your own primary residence. It must stay that way for at least two years. VA loan benefits cannot be applied to buy a friend or relative a house.
Your loan officer will guide you through questions about co-borrowing, joint ownership (be ready to make your titling choice!) and the step-by-step work of document collection. Later on, you’ll make an offer on a home. At that stage, the lender will re-check your credit profile and ask for proof of ongoing income and employment.
Begin Today: Find Personal Guidance
Speak with your area VA loan officer and study the information available to you on VA lenders. It’s important to shop around for the best loan, whether it’s through a military credit union, or a veteran-focused commercial lender that offers lending, refinancing, and loan servicing. Just don’t assume you’ll get the best available terms and rates at any bank that describes itself as VA-approved lender. Due diligence matters!
Your loan officer or a VA-friendly lender can then help you find a real estate agent who knows VA loans, and who knows where best to look for properties that fit the VA’s applicable guidelines.
What other guidance can your VA loan officer offer? You might ask whether paying points — that is, paying some of the interest off upfront to lower your interest rate — will be a smart move in your situation.
With a VA loan, your loan officer will explain, you will not need to pay for private mortgage insurance (PMI). But you should get an idea of what you’ll need to set aside for closing costs, and expect to pay a funding fee, unless you are exempt.
Finally, be prepared for a regimented loan payoff. The VA requires on-time payments every month. If you’re having difficulty making a VA loan payment, never wait. Act promptly to get in touch with your loan representative or a Veterans’ loan technician at 877.827.3702.
Welcome home, veteran!
Photo credit: Jacob Morrison and Jessica Radanavong, via Unsplash.