If you’re a veteran or an active-duty member of the military, the idea of owning a home one day might give you warm, fuzzy feelings. Or maybe it’s just the idea of not having to move again.
When that day comes, you’ll find yourself researching mortgages, and you may go straight for the Veterans Affairs (VA) home loan.
VA home loans look attractive: They come with lower interest rates, lower closing costs and no private mortgage insurance (PMI), plus you can put 0% down.
But before you jump right into signing papers, it’s worth taking a closer look to find out if a VA loan is your best option.
What Makes a VA Home Loan Different?
A VA home loan is a type of mortgage that helps service members, veterans and eligible surviving spouses become homeowners. You can’t use a VA loan on an income property or a second home; these loans can only be used for your primary residence.
VA loans are provided by private lenders — banks, mortgage companies, etc. — and usually backed by the government for up to 25% of the loan if the homeowner defaults.
Because 25% of the loan is guaranteed by the government, banks can lower eligibility requirements and don’t require you to pay private mortgage insurance.
That means veterans with lower credit scores are frequently approved for more mortgage than they would be otherwise.
“[VA loan] lenders tend to approve a higher mortgage-payment-to-income ratio and a higher total-debt-to-income ratio,” said Doug Nordman of The Military Guide.
But perhaps the most appealing feature of a VA loan is that you can put 0% down.
This might look like a deal, especially on a private’s housing allowance, but you’ll pay for it in other ways.
The Hidden Expenses of VA Loans
Before we compare VA loans with other options, let’s look at interest rates vs. APRs, or annual percentage rates. The interest rate is the amount you’ll pay each year to borrow money. The APR includes not just the interest rate, but also charges and fees from the mortgage broker.
VA loans have lower interest rates than conventional loans, but their APRs are higher.
At the time of this writing, one lender was offering a 30-year fixed conventional loan at a 4.62% interest rate with 4.69% APR, and a 30-year fixed VA loan at a 4.5% interest rate with 4.8% APR.
That’s because the VA loan has a funding fee. Instead of paying a set monthly charge for private mortgage insurance (PMI) to the bank, veterans pay a funding fee to the VA that is added at the beginning of the loan and compounds monthly.
The funding fee for regular military is 2.15% when you put 0% down, though it can be lowered by putting a down payment of 5% or more on the house.
For those in the reserves or National Guard, the funding fee is even higher at 2.4%.
It’s easy to look at the numbers with rose-colored glasses because you can afford the monthly payment. But it’s important to look at the big picture when taking on a loan of that size.
When you look at the breakdown of your mortgage, the funding fee will look lower than a PMI payment, but you can get rid of PMI when you reach 20% equity in your home. Unless you pay your funding fee upfront, it stays with you forever.
To put it in perspective: A $200,000 home with $0 down will have a funding fee of $4,300. That $4,300 gets put on the principal, which means you’ll be paying interest on it for 30 years. Even if you refinance, that $4,300 stays there.
Who Is a VA Loan Good For?
The funding fee doesn’t mean the VA loan is bad — it has lots of features that make it a good choice for many service members and veterans. Interest rates are lower, appraisals are more affordable, origination fees are capped at 1%, and you can qualify at a lower credit score.
But it’s even better if you can get the funding fee waived.
Those eligible for a waiver are:
- Veterans who receive VA compensation for a service-connected disability.
- Veterans who would be entitled to receive compensation for a service-connected disability but are receiving retirement or active-duty pay.
- Surviving spouses of a veteran who died in service or from a service-connected disability.
Over 4 million veterans receive VA disability compensation, so a waiver is actually an option for a lot of Americans.
The bottom line: Don’t rush a decision as big as home ownership.
“Research indicates that nearly half of all veterans move yet again within two years of leaving the military, because their bridge career doesn’t work out,” Nordman said. “They end up putting that ‘forever home’ right back on the market, or — even worse — becoming reluctant long-distance landlords.”
Waiting until you’re location-stable will give you time to build your credit and qualify for the best home loan available.
Jen Smith is a staff writer at The Penny Hoarder. She gives money saving and debt payoff tips on Instagram at @savingwithspunk.
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