Why Does the VA Loan Program Not Require Down Payments?

Why the VA Does Not Require a Down Payment

VA Loans Dont Require Down Payments

This is a common question about the VA loan program because it seems too good to be true – “I can get a home loan without making any down payment when normally you have to make a 20% down payment? Yeah, right…” If you don’t know much about the VA loan program, that might even sound like a scam. It’s not. You really don’t have to make a down payment if you get a VA loan. However, that doesn’t mean that no money will be due at the time of closing on a VA loan. We’ll go into that as well as explaining the numbers behind why the VA loan program doesn’t require any down payments.

 

You’ll Still Have Money Due at Closing

“No down payment” is often confused with “No money down”, which is something different. While you can have a true no-money-down VA loan, that’s usually only available as a refinance by using the VA streamline option. The only other way to get a no-money-down VA loan is if the lender chooses to offer one, which will only be done if the money is being made up in some other way such as a higher interest rate. The down payment goes towards paying down the principal balance on the home, and it’s important to lenders because they want the object securing the loan to be worth more than the loan is being made for. Closing costs are different; closing costs are the fees and charges associated with getting a home loan. The VA does not allow closing costs to be rolled into the loan amount unless it’s a streamline refinance, so you’ll be looking at paying a few thousand dollars upfront on a VA loan even if you’re not making a down payment. Part of closing costs is the VA Funding Fee, which can be rolled into the loan amount if you would like, or you can pay it upfront as well. Many veterans are exempt from the Funding Fee, so it’s worth checking to see if you might be as well.

 

So Why No Down Payment?

As we touched on above, the lender needs to have a reasonable assurance that they will get their money back, and preferably a healthy return on their investment. One of the most important ways they do that is by requiring at least a 20% down payment on the house or the borrower purchase mortgage insurance. The reason why is because the house is the security for the loan; in other words, if you default on your loan, the lender takes the house as compensation. In a scenario where 20% of the value of the house has been paid off, the lender needing to sell the home at 85% of its fair market value in order to get rid of it quickly is not a big deal; they still get a small return on their investment. The last thing a lender wants is to make a loan for $100,000, only get $5,000 back from the borrower before they default, and then only be able to sell the home for $80,000, because that means the lender loses $15,000 on the transaction. In that same scenario, if the borrower had made a 20% down payment ($20,000), then paid $5,000 before defaulting, and the lender could only sell the house for $80,000, the lender gains the $5,000 that the borrower paid.

 

It may seem odd that the VA loan program lacks this protection, and if it really did it would be odd indeed. However, the VA loan program has its own protection called the VA Guarantee, and it is designed to eliminate the need for the borrower to make a down payment. Borrowers are still able to make a down payment if they wish and are encouraged to do so if they can afford it, but the Guarantee takes care of the minimum requirements that lenders need in order to be willing to make loans. The VA guarantees 25% of the loan amount to the lender when the loan is made. In other words, if the borrower defaults on the loan, the VA will pay up to 25% of the loan amount to the lender on their behalf. This puts the lender on even better ground than a 20% down payment and makes it even more likely that they’ll be able to at least break even and even turn a small profit on the transaction. Obviously not nearly as much as they would if the borrower had not defaulted, but enough that the risk is sufficiently mitigated.

 

Even though the Guarantee is paid to the lender when it’s used, it’s in place to help borrowers by eliminating the need for a down payment and opening up homeownership to more veterans sooner.

 

The Maximum Amount for VA Loans and Downpayments

For those looking for a new home, and hoping to use a VA loan to finance it, questions about how much you’re able to borrow on a VA-guaranteed loan have probably arisen. You may be wondering about the maximum entitlement that you have, as well as what your interest rate and monthly payment would be at that maximum, so you know whether you could afford it. It may surprise you to find out that there is no national “standard” about how much you can borrow on a VA loan. The amount you can borrow depends a lot on the county you live in. The VA posts a list every year of the loan limits for each county in the United States. If your county is not on this list, it has a maximum of $417,000 that can be borrowed. That list can be found here: http://benefits.va.gov/homeloans/documents/docs/2013_county_loan_limits.pdf

As you can see from that list, there are several places that have over a million dollars that can be borrowed using a VA loan. A lot of places have maximums in the $600,000 and $800,000 range, but the lowest amount a county can have as its maximum is $417,000. While having higher loan amounts is great, if you think about paying off $800,000 with 4.5% annual interest over 30 years, you’re looking at over $4,000 for your monthly payment, which is far more expensive than most people can afford. In the great majority of places, very decent living accommodations can be purchased for under the $417,000 maximum that many counties have. But, if you’re a veteran and a successful business owner or well-to-do executive, getting a VA loan to purchase the big house on the hill is a much better deal than getting a conventional loan to do so.

It is good to know that even the numbers on that list are flexible based on other factors. Let’s say you find a house for $416,000, and you fall in love with it and want to buy it. The good news is, it falls under the maximum amount for your county, so you get the ball rolling and even sign an agreement to purchase with the seller. Then the VA appraiser comes and appraises the home, and says that the fair value of the home is only $350,000. Guess what? You will not be approved for a dime more than $350,000, even if the seller won’t budge on the price and you strongly disagree with the appraiser. There is an appeal process if you think there were errors on the appraisal, but if the appraisal stands then you will not be approved for the higher amount, even though it is under the “maximum” amount that can be borrowed in your county.

Unfortunately, it doesn’t work the other way around. If you’re in a county where the limit is $417,000, and you want to buy a home at $500,000, even if the appraiser were to establish $500,000 as the fair market value, you still could not be approved over the $417,000 limit. The VA will only approve the lower value between the county limit and appraised value of the home. This can cause consternation, especially when the appraised value of the home isn’t that much higher than the county loan limit. However, in these situations, all hope is not lost. In the event that the borrower wishes to buy a home that is more expensive than the county loan limit in which the home is, the borrower can make up the difference in their down payment.

One of the great things about the VA loan program is that VA loans do not require a down payment at all. If you don’t make a down payment or make a small one, you’ll pay a larger funding fee to the VA and have a larger monthly payment throughout the mortgage because you’re paying off more principal, but it can be a great option for those who don’t have enough money saved up for a down payment to still be able to get the home they want and need. But paying a down payment to get the loan amount low enough to be under the county limit can be a great way to get the home you really want. As always, it’s wise to get a lender involved as soon as possible in your house hunting so fewer things catch you by surprise and you can make the best decision for your budget in the long run.

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