The trouble with learning about the VA loan program is that there’s so much second, third, or even fourth-hand information about it. That’s why we’re doing this series; we want to give you information straight from the VA Lender’s Handbook. In the previous chapters of the VA Lender’s Handbook, we’ve talked in-depth about the VA’s requirements for lenders who wish to offer VA loans, as well as eligibility requirements for any potential borrower who wishes to take advantage of the VA loan benefits. In the next five articles, we’ll be going over Chapter 3 of the VA Lender’s Handbook. This article will focus on explaining the basic elements of a VA-guaranteed loan.
In the Handbook, a large and long table is presented that explains VA loans subject-by-subject. The first subject it covers is “Maximum Loan Amount”. The maximum loan amount for a given property depends on two things: the reasonable value of the property indicated on the Notice of Value (NOV) given after the official VA appraisal, and the lender’s needs in terms of secondary market requirements. Next is Downpayment. The Handbook offers this explanation: “No downpayment is required by VA unless the purchase price exceeds the reasonable value of the property, or the loan is a Graduated Payment Mortgage (GPM). The lender may require a downpayment if necessary to meet secondary market requirements. “
The Handbook defines the “Amount of Guaranty” simply as the amount that the VA may pay a lender in the event of loss due to foreclosure. For most loans, this will amount to 25% of the loan value. While this doesn’t directly affect anything the buyer does, it is still good to know exactly how the VA loan program works. For example, a borrower who is under the impression that the VA guarantees 100% of the loan value will probably wonder why VA lenders charge more than a 1% interest rate since there’s practically no risk involved. Knowing that only 25% of the loan is guaranteed explains why VA loan rates are often lower than conventional, but still enough to cover any risk the lender is taking on the loan.
Another element of a VA-guaranteed loan is occupancy. In order to qualify for a VA loan, the borrower must certify that they intend to use the property being purchased as their primary residence. The purpose of the VA loan program is to enable veterans to purchase suitable housing on terms that they can afford, thus enabling them to become homeowners much sooner. On that note, the Purpose of Guaranty as described by the VA Lender’s Handbook is to encourage lenders to make VA loans on terms more favorable to borrowers, since the lender is guaranteed between 50% and 25% of the loan. This minimizes the risk the lender is taking on the loan and gives them an incentive to offer VA loans.
Another element of a VA loan is how the interest rate and points are calculated. They are actually negotiated between the lender and the veteran. Paying for points means giving cash up-front (at closing) in exchange for a lower interest rate. Points are involved enough to justify their own article, and we’ll be covering them more in-depth in future posts, but the table in Chapter 3 lists the following important points: the borrower and seller can negotiate for the seller to pay for some or all of the points, points must be “reasonable”, and points cannot be rolled into the loan amount except for an IRRRL (Interest Rate Reduction Refinance Loan).
The first thing that shows for “Underwriting” is “Flexible standards”. The VA knows that it cannot possibly write a rule or guideline for every possible scenario, and it encourages the underwriters to be flexible in working with borrowers to get them their house. The veteran must have satisfactory credit and a satisfactory ability to repay the loan. This definitely means a stable income and an acceptable debt-to-income ratio (41% or below), but can also include residual income.
We mentioned earlier a thing called an IRRRL. This is the VA’s streamline refinance option. IRRRLs are awesome because no appraisal or underwriting is required and closing costs can be rolled into the loan amount. IRRRLs won’t work for every refinance – generally only those that result in a lower interest rate. The last three elements of a VA loan covered in this table are the funding fee, closing costs, and security instruments. The funding fee is paid by the veteran, is calculated based on the veteran’s eligibility status and down payment, and can be financed into the loan. Closing costs are limited by VA regulations and will be covered more in-depth in future posts. Security instruments are notes or mortgage forms that lenders can use as long as they contain the VA-required clauses.