Nearly any mortgage lender will tell you a VA loan is one of the very best deals in the industry. Some would even say it’s the best.
But despite all its benefits – no down payment, relaxed credit guidelines, and less restrictive income requirements – there are disadvantages of a VA loan.
There are only a few, but they’re well worth being aware of before applying for a loan. In some cases, you may even need to apply for a different type of financing.
What are the disadvantages of a VA loan?
1. You’ll Have Zero Equity in Your Home
This one is somewhat ironic, because it’s perhaps the biggest advantage of a VA loan, but it can also be a disadvantage.
100% financing means a zero down payment. That’s a sweet deal at the time of purchase.
After all, you won’t need to come up with any money out-of-pocket to make the buy. And if the seller or the lender will pay the closing costs and escrows, you can buy a home with no cash outlay whatsoever. So far so good.
But once you move into the home, you’ll own a property that’s 100% financed. In fact, when the VA funding fee (see section #4 below) 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 little more than 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 become a major problem.
For example, if you need to sell the home and you have no equity, you may be forced to write a check at the closing table to cover any closing costs associated with the sale. If the value of the home falls significantly, the check will have to be even bigger.
In a real way, VA loans hold the possibility of needing to make a down payment equivalent on the sale. That’s not a common outcome, but it is a potential disadvantage to be aware of.
2. VA Loans Cannot be Used to Purchase Vacation Homes or Investment Property
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. That isn’t to say you can’t use a VA loan to purchase a home that provides rental income.
You can purchase a property that has up to four units, in which you occupy one, and rent out the other three.
But if you were to purchase the same property, planning to rent out all four units, it won’t be eligible for VA financing.
For that matter, you won’t be able to use an FHA mortgage either. But conventional mortgages can accommodate both second homes and investment properties.
However, understand the guidelines are more restrictive.
You’ll have to make a larger down payment and have a better credit profile and a lower debt-to-income ratio to qualify.
VA loans are an excellent choice for your primary residence, but they can’t help you finance other types of properties.
3. Seller Resistance to VA Financing
In truth, VA loans are only slightly more complicated than conventional mortgages, if they’re even more complicated at all.
But many sellers think back to a time, just a couple of decades ago, when VA loans were more restrictive. This was particularly true with the condition of the property.
But the VA has largely streamlined the process, making it very close to that for conventional mortgages. Unfortunately, not all sellers are fully aware of that.
But there still are some VA loan factors that might make a seller uncomfortable:
- VA appraisals. VA appraisers do impose minimum property requirements (MPRs), requiring a home to meet agency guidelines for safety and livability. However, this is largely true of all mortgages, including conventional loans, so it’s something of a myth.
- 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 a 0% down payment, will be highly likely to seek seller paid closing costs as well. If the seller is reluctant to pay these, he or she may frown on accepting an offer with a VA loan attached to it.
- Delays due to paperwork. Because VA loans involve dealing with a government agency, delays due to paperwork can extend the closing process. This is particularly true if the veteran is either slow to obtain a VA Certificate of Eligibility, or if there’s a problem with the certificate.
In reality, none of these perceived obstacles are as significant as many sellers believe them to be.
But perception can be hard to overcome, and some sellers may definitely need to be persuaded by a good real estate agent to accept an offer that includes a VA loan.
4. The Funding Fee is Higher for Subsequent Use
VA loans come with an upfront charge, known as the VA funding fee. This is a fee 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.
This is basically private mortgage insurance for VA loans. Conventional and FHA loans also have mortgage insurance, and both collect it on a monthly basis (FHA also has an upfront charge).
One of the major benefits of a VA mortgage is the absence of monthly mortgage insurance.
But one of the disadvantages with the VA funding fee is that it’s higher for subsequent use.
The increased fee looks like this:
- Regular military: 2.15% for the first use, 3.3% for subsequent use.
- Reserves and National Guard: 2.4% for the first use, 3.3% 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 $4,300. A subsequent use on the same loan amount will be $6,600.
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 $204,300. But upon subsequent use, the loan amount will be $206,600.
If you’re paying a 4% interest rate on your mortgage, the monthly payment on a first use loan amount of $204,300 will be $975.
A 4% rate on your mortgage for a subsequent use loan amount of $206,600 will be $986. That’s only $11 more per month, but it adds up to $3,960 over the 30-year term of the loan.
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 as well. The relatively limited number of VA lenders has the potential to narrow your options for funding sources.
Some lenders do offer VA loans but provide them only infrequently. This type of lender makes a major contribution to the negative perceptions sellers have of VA loans.
Because of their lack of experience, the loan process takes longer, and mistakes along the way that can make the closing process uncomfortable for both the buyer and the seller.
In extreme circumstances, a seller may revoke the contract. This can often be done automatically because real estate contracts typically include language requiring the buyer to obtain financing by a specified date.
If the veteran is unable to do so by the cutoff, the seller can simply refuse to extend the deadline.
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.
If they had a good experience with those lenders, they should be high on your list of financing sources.
Final Thoughts on the Disadvantages of VA Loans
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 to be a more informed consumer.
To do that, you’ll need to be aware of the disadvantages as well as the benefits.
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 sides of the VA loan process, including those that might not be entirely pleasant.
But armed with this information, you should be able to successfully work around disadvantages of VA loans, and purchase the home of your choice.