What is the VA Funding Fee For?
The VA funding fee is best understood in context. To establish the context, we need to talk about conventional mortgages and FHA loans. First we’ll talk about conventional loans and how lenders protect themselves from too much risk when closing conventional loans. Then we’ll talk about the FHA loan program, and how the FHA keeps the expense of the FHA program from being too large of a burden on taxpayers. Then we’ll talk about how the VA compares with those programs and why the VA’s method is much better and far more advantageous to veterans than either of the other two programs. The underlying principle for these programs is how to minimize the risk to lenders without being a large expense that taxpayers have to cover.
In the conventional loan program, there’s generally no government subsidies, so the latter concern about the burden on taxpayers is not really a concern. Minimizing the risk to lenders, however, is a big deal, and generally speaking, a lender requires a 20% down payment from the borrower to help minimize their risk. In that way, even if the borrower defaults on the very first payment, the lender already has 20% of the home’s value in their pocket, and so can sell the home at 80% of its value without incurring a loss. You can get a conventional loan without making a 20% down payment, but the lender will likely require you to purchase mortgage insurance, which can add hundreds of dollars to your payment each month, depending on the value of your home. $200/month for mortgage insurance is a little bit higher than average, but certainly not rare, and means you’ll be spending $2,400 per year more than you would have had to if you made a down payment.
Now to the FHA program. The FHA loan program is where lenders offer a loan that the FHA guarantees similar to the way the VA guarantees VA loans. The FHA loan program is available to anyone, however, and does not offer nearly as many advantages as the VA loan program. On every loan, regardless of down payment, the FHA requires mortgage insurance. The purpose of the FHA loan program is to help borrowers who couldn’t otherwise get a loan to do so. It’s not about getting borrowers better terms and its certainly not considered a benefit of any kind of service. Assuming it takes 5 years for an FHA borrower to be ready to refinance to a conventional loan, that borrower has paid $12,000 in mortgage insurance; an insanely high expense. The FHA requires mortgage insurance because some people default on their mortgages, and the FHA pays the lender the guaranteed amount if that happens. This costs a great deal of money, and by requiring the borrower to get mortgage insurance, the FHA passes a great deal of the cost off of the backs of taxpayers.
Enter the VA loan program. Now that we understand that every loan program is concerned about minimizing the risk to lenders and making sure the taxpayer burden is not too large in order to do so, the VA funding fee makes a lot of sense. Rather than requiring a monthly payment that can easily cost you $10k over the next few years, the VA charges a one-time VA funding fee, usually in the amount of 2.15% (more if for a Guard/Reservist or for second-time use, less if the borrower makes at least a 5% down payment). On a $200k house, the VA funding fee would be $4,300. As mentioned before, that percentage drops dramatically if you make at least a 5% down payment, and even more if you make a 10% down payment. Statistically speaking, borrowers who make a down payment are much less likely to default on their loans, so the VA is willing to charge a smaller funding fee for those borrowers.
The VA has a lot of faith in its borrowers, and wants to do as much as possible to get veterans the best terms they can get at as low a cost as possible. The one-time funding fee goes towards paying for the VA loan program so taxpayers don’t have to pay as much, and is far more reasonable than paying for mortgage insurance.