Do VA Loans Have Mortgage Insurance?
This question touches on one of the greatest benefits of the VA loan programs. In fact, the answer to this question is directly related to the thing that makes the VA loan program exist at all – the VA guaranty. The short answer is no. VA loans do not require the borrower to purchase mortgage insurance, even when no down payment is being made. This is one of the things that makes the VA loan program such a valuable asset for borrowers. Not only do VA loans not require borrowers to make a down payment of any kind, but they also do not require mortgage insurance, even when the borrower makes zero down payment.
Have you ever wondered why? What makes this possible? Well, anyone who has purchased a home before is probably familiar that lenders will require a 20% down payment on the home for a conventional loan, and usually at least a 5% down payment on an FHA loan. The FHA offers the lender a guaranty to help mitigate their risk, and the FHA charges the borrower mortgage insurance in exchange for helping the borrower get a loan and to cover the FHA’s risk. Similarly, the VA guarantees a certain percentage of the loan to the lender so the lender will not require a down payment. In exchange, the VA charges the borrower a one-time funding fee, which adds a few thousand dollars to closing costs for the loan. Considering that mortgage can cost upwards of $200/month in some cases, the 2.15% one-time funding fee is a far better alternative.
Understanding the VA guaranty is important in understanding why it can negate the need for a down payment. We already know that mortgage insurance is simply how the FHA lowers their risk and thus the financial burden on the taxpayers for their program, and the VA funding fee (not to mention the military service of the borrowers) is how the VA lessens the financial burden of their program. But the lender’s biggest concern is losing money on a loan. Have you ever wondered why lender’s require a 20% down payment? Well, up until very recently, the federal government required that they do so, but as of October 2014, that has changed. The government no longer requires that borrowers make a down payment at all on a conventional loan. However, you’ll find that many lenders still ask for a 20% down payment, or at least penalize a borrower with a higher interest rate for not having that much put down, and there’s a very good reason why.
The lender, and any investor who purchases your loan, is taking a sizable risk ($300k is a lot of money) and the chance that you will pay back the amount owed dutifully either by paying through to the end of the mortgage or selling your home after a few years. Unfortunately, especially in today’s economy, people default on their loans all the time. Getting 20% of the loan in a down payment is usually enough that if the borrower defaults, the lender can make most of their money back selling the foreclosed home to a new buyer. When the borrower doesn’t make a down payment, it’s essentially a guarantee that the loan holder will lose a lot of money if the borrower defaults. Enter the VA guaranty.
The VA guaranty stands in for the down payment. On a normal (non-jumbo) VA loan, the guaranty amount will be at least 25%, more than covering the percent that the lender wants taken care of risk-free. This also explains why a borrower making a 20% down payment on a conventional loan and a borrower making no down payment on a VA loan will get offered similar terms. A borrower who makes a 20% down payment on a VA loan will likely be very pleasantly surprised at how good the terms are, since, in that scenario, 45% of the value of the home is completely risk-free.
So there you go, I hope that not only answers the question about mortgage insurance, but also helps you understand a bit more about how the VA guaranty works, why the VA doesn’t require mortgage insurance, and the relationship between the VA guaranty, the down payment, mortgage insurance, and the funding fee.