Deciphering the VA Lender’s Handbook Chapter 7 Part 6
The previous articles on Chapter 7 of the VA Lender’s Handbook covered joint VA loans in entirety. Since joint VA loans are not only fairly common but also a good deal different from normal VA loans, there is a great deal to discuss and clarify about them. This article will begin to cover construction loans through the VA loan program. As of the writing of this article, there are very few VA-approved lenders that are willing to offer construction loans even though the VA permits them. As the market changes, this could change as well, and if you’re looking at getting a construction loan, this article will have a great deal of valuable information.
The VA will guarantee a construction loan just as they will guarantee the purchase or refinance of an existing house. The construction loan must be closed before construction begins, and immediately covers the cost of the land, with the remaining balance (for the actual building of the house) put into escrow. The money in escrow is paid out as needed throughout the construction process. As the borrower, you will be required to provide written approval to the lender before the lender can draw money from the escrow to pay the builder. Loans to purchase a residence that the borrower built from his or her own resources are not considered construction loans.
Amortization on a construction loan can be tricky. The veteran is not permitted to begin making payments on the loan until construction is complete on the house, but the full term from the date of closing is still not allowed to be longer than 30 years and 32 days. Therefore, the loan must be amortized in a way to achieve full repayment within the remaining term. In other words, a 30-year mortgage that takes 1 year to complete construction on the home will need to be amortized to be fully paid off within 29 years. The lender can do this in one of two ways: a balloon payment or an adjusted amortization schedule. A balloon payment is where the lender requires a significantly larger final payment than has been paid each month throughout the rest of the term. In other words, the borrower makes up the amount that was not paid during the construction period at the end of the loan.
The other option is for the lender to adjust the amortization schedule so that the loan fully amortizes in the amount of time remaining instead of the full term. In the above example, the lender would recalculate the monthly payments for the loan to be paid off evenly over 29 years instead of 30. In essence, this is turning a 30-year mortgage into a 29-year mortgage. For most borrowers, this is preferable to a balloon payment at the end of the mortgage that could be up to 5% of the original loan amount.
With construction loans, one of the concerns is determining who pays what. First, we must establish the parties involved in a construction loan. There are the borrower, the lender, and the builder (the VA is also involved, of course, but they don’t pay for anything). The builder is required to pay the interest payments during the construction period, and all the fees that a builder would normally pay when they obtain an interim construction loan, including (but not limited to) inspection fees, commitment fees, title update fees, and hazard insurance during construction. The builder is not allowed to bill the lender or the borrower or these items; they are considered a cost of doing business for the builder.
Fees that are payable by the borrower and lender are not different from any other type of VA loans, and will be covered more in depth in Chapter 8 of the Handbook. If you’re looking for more specific information about your situation, and what fees you can be required to pay, it’s best to speak with a VA-approved lender and give them all of the relevant details. In the following article, we’ll discuss construction loan interest rates, funding fees, the LGC, and what is done with remaining funds in escrow after construction is complete.