A VA loan may be one of the best deals in the mortgage industry. But despite benefits including no down payment, relaxed credit guidelines and less restrictive income requirements, there are disadvantages of a VA loan.
These disadvantages are worth being aware of before applying for a loan, and in some cases you may need to apply for a different type of financing.
What are the Disadvantages of a VA Loan?
The purpose of this list isn’t to discourage you from applying for a VA loan if you’re a veteran. Rather, it’s to help you be a more informed customer.
A big part of the “mission” at The Military Wallet is to equip you with all the information you’ll need to successfully purchase a home with a VA loan. That requires knowing all the aspects of the VA loan, including those that may present challenges. But armed with this information, you should be able to successfully work around the disadvantages of VA loans, and purchase the home of your choice.
1. You May Have Less Equity in Your Home
Being able to buy a home with little or no money down is one of the biggest advantages of a VA loan. One-hundred percent financing means a zero-down payment, and you won’t need to come up with any out-of-pocket money to make the purchase. If the seller or lender pays the closing costs and escrows, you can buy a home with no cash outlay whatsoever.
But buying a home with no down payment can also be a disadvantage.
Once you move into the home, you’ll own a property that’s 100% financed. When the VA funding fee is added to the loan amount, you’ll actually be in a negative equity position from the very beginning.
If the property you’re purchasing is in a rising market, that’s likely only a temporary problem. As the value of your home increases, and you begin paying down your mortgage balance, you’ll gradually build equity. But if the market is either flat or declining, it can be a problem.
2. VA Loans Cannot be Used for Vacation or Rental Properties
One of the primary limits of VA loans is that they can only be used to purchase or refinance owner-occupied properties. If you want to purchase a vacation home or investment property, you’ll need to use conventional financing.
You can use a VA loan to purchase a home with up to four units providing rental income, but you must occupy one and rent out the other units. If you purchase the same property with the plan to rent out all four units, it won’t be eligible for VA financing.
3. Seller Resistance to VA Financing
VA loans are only slightly more complicated than conventional mortgages, but just a couple of decades ago, VA loans were more restrictive. This was particularly true with respect to the condition of the property.
The VA has streamlined the home-buying process, but not all sellers or their real estate agents are fully aware of the improved application process.
There still are some VA loan factors that might deter a seller:
- VA appraisals. VA appraisers do impose minimum property requirements (MPRs), requiring a home to meet agency guidelines for safety and livability. The home value must also appraise for the purchase price in order to qualify for a VA loan.
- Seller paid closing costs. These are common in some markets, but they’re extremely typical with VA loans. A veteran who is purchasing a property with no down payment will be highly likely to seek seller-paid closing costs as well. If the seller is reluctant to pay these, they may be wary to accept a VA loan offer.
- Delays due to paperwork. Because VA loans involve dealing with a government agency, paperwork delays can extend the closing process.
4. The Funding Fee is Higher for Subsequent Use
VA loans come with an upfront charge, known as the VA funding fee. Note: The VA Loan funding fee is waived for qualifying veterans, including those with a service-connected disability rating.
The VA Loan funding fee is collected by the Veterans Administration to insure loans made under the program.
For example, if a VA borrower defaults on their mortgage, the VA will reimburse the lender for a certain percentage of the loan if the foreclosure sale of the property is insufficient to pay off the entire balance.
One of the disadvantages with the VA funding fee is that it’s higher for subsequent use.
The increased fee looks like this:
- No Down Payment: 2.30% for the first use, 3.60% for subsequent use.
- 5% Down: 1.65% for the first use, 1.65% for subsequent use.
To translate those percentages into dollar figures, a first-time use of the VA loan for $200,000 will result in a VA funding fee of $4,600. A subsequent use on the same loan amount will be $7,200.
In most cases, the funding fee is added to the loan amount. On the first use, the loan amount including the funding fee will be $204,600. But upon subsequent use, the loan amount will be $207,200.
If you’re paying a 4% interest rate on your mortgage, the monthly payment on a first use loan amount of $204,600 will be $977 (before taxes and insurance).
A 4% rate on your mortgage for a subsequent use loan amount of $207,200 will be $989. That’s only $12 more per month, but it adds up to $4,320 over the 30-year term of the loan.
That said, the VA waives the funding fee altogether for some veterans, including those receiving VA disability benefits.
5. Not All Lenders Offer – or Understand – VA Loans
There are hundreds of mortgage lenders across the country, but not all offer VA loans. This is often true of banks, but also of many online lenders. The relatively limited number of VA lenders has the potential to narrow your options for funding sources.
This is why it’s so very important to work only with lenders that do a substantial amount of VA loan business. They should have specialists on staff who work primarily or exclusively with VA loans.
That type of concentration streamlines the process and can make VA loans no more complicated than conventional mortgages.
If you’re going to apply for a VA loan, do some serious research on the lender. Get referrals from other veterans who obtained VA loans from local lenders, visit our list of recommended VA Loan providers, or work with a military bank or credit union.
Is the VA Loan Worth It?
Despite the potential disadvantages explained above, the VA loan is still a great option for those who are eligible. There are a variety of aspects that make the VA loan advantageous for the majority of borrowers who choose it.
With the VA loan, there is no down payment required and no PMI. Most borrowers are also able to negotiate seller-paid closing costs as well, meaning no money down initially. Additionally, the VA loan program offers relaxed credit requirements and a higher debt-to-income ratio, meaning you don’t have to have a perfect credit report or be debt-free to obtain a VA loan.
Regardless, it is ideal to talk through your unique circumstances with a lender who is well-versed and practiced in VA loans.
But armed with this information, you should be able to successfully work around disadvantages of VA loans, and purchase the home of your choice.
Equal Housing Opportunity. The Department of Veterans Affairs affirmatively administers the VA Home Loan Program by assuring that all Veterans are given an equal opportunity to buy homes with VA assistance. Federal law requires all VA Home Loan Program participants – builders, brokers and lenders offering housing for sale with VA financing – must comply with Fair Housing Laws and may not discriminate based on the race, color, religion, sex, handicap, familial status, or national origin of the Veteran.