How Do VA Loans Work?

How Do VA Loans Work? article image.

VA Loans are designed to help qualifying veterans, service members and surviving spouses buy or improve a home. They are issued by private lenders but insured by the federal government, and come with a host of benefits.

Lenders who issue VA loans determine which applicants qualify using standards spelled out by the U.S. Department of Veterans Affairs. If you qualify for a VA loan, you can typically finance a home purchase or renovation at a lower interest rate and with a lower down payment than you'd need for a conventional mortgage. You might even qualify for a 0% down payment loan, without having to pay the private mortgage insurance (PMI) typically charged on conventional mortgages with down payments of less than 20%.

What Is a VA Loan?

The VA loan program is a benefit offered to veterans, active duty troops, National Guard members and qualifying spouses in recognition of the hardships of military service.

There are three types of VA loans currently available to qualifying applicants:

  • VA purchase mortgage: Comparable to a typical home mortgage loan, this can be used to purchase a single-family home or a multi-family home with up to four units, as long as the property will be your primary residence.
  • VA interest rate reduction refinance loan (IRRRL): This lets you replace an existing VA Loan with a new one that carries a lower interest rate and lower monthly payments. It may allow you to replace a VA-backed adjustable-rate mortgage (ARM) with one that has a fixed interest rate, to make payment amounts more predictable from year to year.
  • VA cash-out refinance loan: This lets you replace an existing conventional mortgage with one backed by the VA, which likely will have lower interest rates. It also may enable you to use equity in your home as collateral on a cash loan or line of credit that you can use for home remodeling or repairs, or to repay student loans or other debts.

Who Qualifies for a VA Loan?

There are three basic criteria you must meet to qualify for a VA loan:

  • Certificate of eligibility: When applying for a VA loan, you must provide each lender with a copy of a certificate of eligibility (COE) issued by the VA. The COE verifies that you or your spouse meet the military service requirements needed to qualify for a VA loan.
  • Income: You must have steady income that will allow you to cover the monthly loan payments. Specific income requirements will vary by lender and could depend on the price of the property or renovations the loan will be used to purchase.
  • Credit: You must meet the lender's credit requirements, which typically include having a credit score above a specified threshold or "cutoff" value. Lenders set their own credit requirements, but they must fall within guidelines spelled out by the VA. Credit standards on VA loans are typically less strict than those on conventional loans.

    Like conventional mortgage lenders, issuers of VA Loans typically charge higher interest rates on loans for borrowers with lower credit scores, and may require some applicants with lower credit scores to take an ARM, for which finance charges and monthly payments can increase annually.

Before applying for a VA loan (or any other mortgage), it's wise to review your credit and take steps to shore up your credit scores so you can get the best interest rates available to you.

How to Apply for a VA Loan

Your first step in seeking a VA Loan should be obtaining a COE. Requirements differ somewhat depending on the nature of your service (or that or your qualifying spouse) and whether you're on active duty or have been discharged. The credentials you must present in each case are detailed at the VA website, and may include discharge papers or signed attestations from superior officers, along with proof of ID, date of birth and Social Security number.

Next, choose the type of VA loan you prefer (purchase loan, interest rate reduction refinance loan or cash-out refinance loan), and look for lenders that offer them in your area. Many banks and credit unions offer VA loans; the VA Regional Loan Center for your state can help you locate financial institutions serving your area.

Submit applications to lenders with your COE and any other required documentation, which could include:

  • Proof of ID (government-issued photo ID, birth certificate and the like)
  • Proof of income (pay stub or tax return)
  • Social Security number (needed to perform a credit check)
  • Proof of savings, investments or other assets that could be used as resources to help cover loan payments.

As with conventional loans, it's always a good idea to compare several lenders when seeking a VA loan. Each lender will have some differences in their loan pricing standards, and some may offer you more attractive loan terms than others. Shopping around can ensure you get the best possible deal. Try to complete any loan applications within a two-week period: Credit scoring models see mortgage rate shopping as positive borrowing behavior and will count all the inquiries made as a result of your applications as one, as long as they are done within a short period of time. This will have a minimal (if any) effect on your credit.

VA Loan Alternatives

If you qualify for the VA loan program, you'll likely get the best deal available on a home loan, But if you don't qualify for any reason, there are other options available for home purchase and home improvement loans, including:

  • FHA loans: These mortgages, backed by the U.S. Federal Housing Administration, are designed to help first-time homebuyers purchase homes. They allow qualifying borrowers to buy homes with down payments as low as 3.5%. Borrowers may qualify with lower credit scores than those required for conventional mortgages, but those putting down less than 20% on the purchase must pay private mortgage insurance premiums for the life of their loans.
  • USDA Loans: Backed by the U.S. Department of Agriculture, these loans are designed to help qualifying borrowers buy homes in rural areas of the country. To qualify, borrowers typically must show income below the norm for the area in which they wish to purchase a home.
  • Conventional loans: Conventional home loans, issued by banks, credit unions and other mortgage lenders, typically require larger down payments and higher credit scores than those provided through government-backed lending programs, and may carry higher interest rates and fees. There are a host of private lenders who cater to a wide array of borrowers, ranging from those with both exceptional credit scores to those with less-than-ideal, or "subprime" credit. These loans could cost considerably more over time than a VA Loan or other government-backed mortgage, but if one puts you in a home you need and can afford, it may be the best option for you.

The VA loan is one of the nation's ways of saying "thank you" to those who have made sacrifices in service to our armed forces. They offer the well-earned rewards of homeownership and home improvement to all who qualify.