Is a VA Loan a Good Deal?

Veterans Administration, or VA loans, are government guaranteed loans available to veterans and active duty members of the armed services, that enable them to purchase homes for no money down. In fact, VA loans go up to 103 percent of purchase price to allow for some closing costs as well.



VA loans are a unique creature in the world of mortgages. Because there is a government guarantee on the loan, they are available, usually at the same rate/cost tradeoff, whether your credit is perfect or abysmal. They have a qualification limit equal to the conforming loan limit from Fannie Mae and Freddie Mac, $417,000 as of this writing.



Now, the Veterans Administration runs a website where you can get all kinds of information on VA loans, but I'm going to touch some high points.



VA loans are available both for purchase and for refinance. There is a streamlined program for pure interest rate reductions that can sometimes be at documents in as little as a week. This is called the Interest Rate Reduction Refinance Loan program, or IRRRL, but usually just called a VA streamline. There is, or so I understand, a cash out program as well, but I've never done one of those.



All VA loans have two important feature: Government Guarantee and Assumability. The government will guarantee a certain percentage (usually 25% of the original loan amount), which is more than enough to persuade most lenders that these are loans worthy of a fairly low rate, as they are low risk. A person with a VA loan can allow anyone else to assume it, with the approval of the lender and the VA. They have to prove they qualify for the loan, and the veteran still has responsibility for the loan, and it does count against the total of all VA loans that individual is allowed. Last I checked, prepayment penalties on VA loans were prohibited.



Now the bad news. Even with the government guarantee, the rate/cost trade-off isn't the best. Most VA lenders want at least two discount points for their VA loans, a fact which makes low cost and zero cost VA loans problematical. Even with those discount points, the rate will probably not be as good as A paper. Veterans with good credit, particularly if they have a good amount of equity or a decent sized down payment, will generally be able to obtain a better rate at a lower cost in the A paper marketplace. Even so called A paper "jumbo" loans over the $417,000 limit, or A paper "stated income" loans, will usually have a significantly lower rate/cost trade-off than the VA loan. They're better than just about all sub-prime loans, but they lose out to A paper.



If you have good credit but not much of a down payment, the VA loan can be an option worth exploring. VA loans have no mortgage insurance requirement (aka PMI), that purpose being served by the government guarantee, and so splitting your loan into a first and a second mortgage in order to avoid mortgage insurance, with the second being at a higher rate, is generally not necessary, and your full loan amount can be at the lower rate of the first mortgage. But be careful, because once again, most VA lenders want their two discount points, and maybe more. You might want to read my article on the Trade-off between Rate and Cost in Real Estate Loans and Why You Should Ignore APR for more as to why. Nevertheless, this could go either way and is well worth shopping the loan both ways.



If you have rotten credit, a VA loan can be the only way you can purchase a home, particularly if you have no down payment. Since credit is irrelevant and there's a government guarantee, I used to know a couple lenders that didn't bother to run credit for VA loans. Even the ones that do, it's just a checked box that plays no part in the decision making and underwriting process. Furthermore, you get a rate of a sort that would normally be available only to someone with a much higher credit score than yours.



Now in addition to relatively high closing costs, there are some other games that get played with Veterans Administration loans, of which the Rate Buydown is probably the most pernicious and widespread. But if you're one of those veterans who thought they could never be approved for a loan on a home, VA loans can make it happen where nothing else could.

UPDATE 2/14/2008: With 100% financing programs difficult to come by right now, the fact that second trust deeds don't want to lend over 90% of the value of a property currently, and PMI rates skyrocketing, VA loans have become the absolute best route for 100% financing as of this update. I did the math, and the fact that VA loans are the only 100% financing available right now without PMI or lender paid mortgage insurance saves someone making San Diego Area Median Income over $600 per month, which works out to qualifying for the loan with over $1400 per month less income - $17,000 per year.

Caveat Emptor

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