Deciphering the VA Lender’s Handbook Chapter 7 Part 11
Chapter 7 in the VA Lender’s Handbook is dedicated to going over all of the specialized loans in the VA loan program. Previously covered in articles on Chapter 7 are joint loans, construction loans, and Energy Efficient Mortgages (EEMs). In this article, we’ll be starting on supplemental loans. We’ll start by explaining what a supplemental loan is, then go in depth on the requirements on supplemental loans. This will be the first of two articles on supplemental loans. This type of loan is fairly simple and straightforward and, therefore, does not require too much documentation.
Simply put, a supplemental loan is a loan given to pay for an alteration, improvement, or repair of a residential property. For the VA loan program, a supplemental loan must secure an existing VA-guaranteed loan (the home must have been bought with a VA loan), and the veteran borrower must still own and occupy the home. It is also acceptable if the veteran will reoccupy the property once the alterations, repairs, or improvements are made if they are major. A supplemental loan can only be made for alterations, improvements, and repairs that substantially protect or improve “…the basic livability or utility of the property…” Supplemental loans are primarily restricted to maintaining, replacing, improving, or acquiring real property. For more detail on what that means, consult with your lender on what you’re hoping to do with a supplemental loan, and he or she will be able to tell you if your project qualifies.
Unfortunately, adding new features will often not satisfy the VA’s requirement. The Handbook specifically mentions barbecue pits and swimming pools as not acceptable. No more than 30% of the VA supplemental loan can not be used for things considered “non-fixtures” or “quasi-fixtures”. The examples the Handbook gives are refrigeration, cooking, washing, and heating equipment. Even the 30% must be related to or supplement the main alteration that the borrower is getting the loan for. A good example of this is getting a stainless steel kitchen appliance set to supplement a kitchen renovation.
Unlike with normal VA loans, a supplemental loan does not have to have the first lien on the home (in fact, it never really will). The lender has the flexibility to determine a proper lien for the loan being given. The Handbook lists the following suggestions for lenders to secure the supplemental loan:
- through an open end provision of the instrument securing the existing loan,
- through an amendment of the existing loan security instrument,
- by taking a new lien to cover both the existing and the supplemental loans, or
- by taking a separate lien immediately junior to the existing lien.
The lender will determine the most appropriate way to secure the supplemental loan for a given situation, but the above suggestions are likely scenarios. Supplemental loans can either be amortized or not amortized, and have different maximum loan terms depending on which they are. If the loan is amortized, the maximum loan term is 30 years, but if not, the maximum is 5 years.
The VA also has other requirements for a supplemental loan to be approved. It is required that the existing loan on the home is current in all its aspects – taxes, insurance, and principal/interest payments. The only exception to that rule is when the supplemental loan is going towards something that will improve the ability of the borrower to continue making payments (such as a borrower who has purchased a multi-unit property and cannot rent out another unit without an improvement).
Good news for you as the borrower is that getting a secondary loan is not permitted to affect your interest rate on your existing loan. This does not mean, however, that the interest rate on your supplemental loan will be the same as on your main loan; the supplemental loan may be written at a higher interest rate than the main one. While the interest rate on your main loan will be a consideration for the lender, there are many other factors for the lender to consider, including the increased level of risk on the supplemental loan. There are plenty of cases where the interest rate on the supplemental loan is lower than the main one; it all depends on the situation and context that the loan is being made in.