As any VA borrower knows, VA loans have no shortage of requirements different from conventional loans. What a seasoned borrower may not realize, however, is that many of those requirements, policies, and practices don’t actually come from the VA – many of them come from the lender, and are not found in the VA loan rulebook. Probably the most prominent example is the requirements for borrowers to qualify for certain loan amounts. The VA has their minimum requirements, but nothing in the Lender’s Guide or the VA loan rulebook outlines what standards a bank or lender must use in determining the creditworthiness of a potential VA borrower. Many lenders set higher credit standards than the minimum that the VA requires, and they are permitted to do so as long as the standards they use don’t violate the guidelines in the VA loan program. Another situation that might vary from lender to lender are the expectations and requirements surrounding escrow accounts.
What is an escrow account? To put it simply, an escrow account is money put aside to be used later. In the case of real estate an escrow account can be set up for a variety of purposes. For a new construction loan, an escrow account is usually set up to be available to cover costs of construction as they come. In many existing construction loans, an escrow account is opened for a borrower to make monthly payments into to cover hazard insurance and property taxes. In this case, the lender then makes the payments on behalf of the lender. This sort of set up can be advantageous to both the borrower and the lender. Better for the borrower because it’s far simpler for it all to go into one account, and direct deposit can often be set up to have it come out automatically. It’s advantageous for the lender because they know the borrower is keeping up on insurance and property tax payments, which protects the lender’s equity in the home as much as the borrower’s.
The VA does not actually require an escrow account to pay property taxes and other costs, but a good amount of lenders do. However, it’s good to know that there are legal limits on how much a lender can require a borrower to hold in escrow. An Act, known as the Real Estate Settlement Procedures Act (RESPA), establishes a legal limit to the amount a borrower can be forced to hold in escrow. RESPA also requires lenders to be accountable to borrowers in regards to the escrow by requiring them to provide annual reports that show the balance in escrow. The ability to monitor their escrow accounts is of great value to a borrower. RESPA does not set a requirement for a minimum deposit or what is known as a ‘cushion’, but it recognizes the need for one by allowing lenders to set one for their escrow accounts. The cushion that RESPA allows is up to two months worth of escrow payments: “…equal to one-sixth of the total amount of items paid out of the account, or approximately two months of escrow payments. If state law or mortgage documents allow for a lesser amount, the lesser amount prevails”
It’s important to know the distinction between requirements set by law and requirements set by the lender. If you are aware of what things might vary lender to lender, you can know when a lender is presenting you unfavorable terms, or when another lender might have a better offer. It’s becoming increasingly common for lenders to require the maximum amount allowed by law to be held in escrow, and it’s important to know that the maximum amount has not changed; it is the decision of lenders to require up to the maximum that has changed. Always ask a lender about their escrow terms and requirements, and use that information as a factor in determining which lender to go with.
Generally, escrow terms at a given lender won’t change from loan to loan – they’re generally the same for all loans of the same type – so a prospective lender should be able to let you know very early in the process what their escrow requirements of you will be. Remember that a lender wants to get you a mortgage that you’ll be able to cover without missing any payments and with no threat of a default, so it’s always in the best interest of a legitimate VA-approved lender to offer you the best terms they can.