Mortgages that are backed by the Department of Veterans Affairs are referred to as the VA loan. While the VA doesn’t actually get involved with any part of an approval, it does issue guidelines that lenders must follow in order to receive the loan guarantee. VA loans are one of three of the government-backed programs, FHA and USDA, which also carry guarantees. Note, these guarantees aren’t guaranteeing the applicant will get an approval, but the lender is guaranteed some compensation for the loss should the loan ever go into default.
VA loans are reserved for a select set of borrowers. These include veterans of the armed forces, active duty personnel with at least 181 days of service, National Guard and Armed Forces Reserve members with at least six years of service and unremarried, surviving spouses of those who have died while serving or as a result of a service-related injury. Lenders must verify eligibility with each submitted VA loan application. This is accomplished by ordering a Certificate of Eligibility directly from the VA. Without this certificate in the loan file, the loan cannot be approved as a VA mortgage.
Closing costs for VA loans are restricted for eligible borrowers. Borrowers can only pay for an appraisal and credit report, title insurance, origination fees and recording fees. In areas where surveys are required, borrowers are eligible to pay for a survey. One of these costs, the largest one as a matter of fact, is the VA funding fee.
The funding fee is in essence an insurance policy the borrowers pay for in favor of the lender. This fee can vary based upon the term of the loan, re-use and any down payment. It’s important to note here however that VA loans do not require a down payment, but borrowers may choose to provide one voluntarily. For first time buyers taking out a standard 30 year fixed rate term, the funding fee is currently 2.15 percent of the sales price of the home. For a $300,000 mortgage, that’s $6,450.
That’s quite a bit but remember the lender is approving a mortgage without any down payment. Should the loan soon go into default, there won’t be any equity. There are also legal fees involved in such an instance so typically the lender is automatically upside down if the lender is forced to foreclose. However, this is rare as VA loans are some of the highest performing financing products in the industry.
The guarantee to the lender is 25 percent of the loss. Again, with an outstanding mortgage balance of $300,000, the lender is paid $75,000. This guarantee can also allow a lender to approve a zero down loan that it may not have approved with a low down payment conventional loan. It’s the funding fee that finances this guarantee to the lender.