Mortgage programs outlined by the Department of Veteran Affairs, with alluringly low interest rates and zero money down, seem too good to be true for real estate investors. And they are… sort of.
While it’s true that these loans are designed to help service members purchase homes, not investment properties, they still present an opportunity for investors. Are they a fast-track to creating a real-estate portfolio? Maybe not. But for those who might not otherwise be able to jump into the world of investing, VA loans offer a way to save money and bring in some cash.
Savings for Service Members
VA loans were created by the U.S. government in 1944 to enable service members to purchase their own homes. Veterans, active members of the military and their families can take advantage of the program. The mortgages, although offered by private lenders, are backed by the government and come with very attractive terms, terms that conventional loans just can’t match.
Those terms include:
- No down payments
- Lower interest rates
- No PMI (private mortgage insurance) requirement
- Limited closing costs
- No pre-payment penalty (fee for paying the loan off early)
It’s easy to see how quickly the savings can mount. Consider the purchase of a home costing $200,000. Immediately, the qualifying borrower can eliminate the need for what would most likely be a down payment of $40,000, or 20 percent. That amount would be required to avoid PMI, which could be another $166 a month assuming a rate of 1 percent on the full loan amount of $200,000.
Since these loans are guaranteed by the government, lenders generally offer them at lower interest rates. A VA loan at a rate of, say, 3 percent as opposed to a conventional loan at 4 percent could save you close to $40,000 over 30 years on that $200,000 home. The savings continue to grow when you factor in VA limits on closing costs. If you’re thinking of investing in real estate, terms like these certainly make it easy to get started.
Clearly VA loans are a cost-effective way to finance a home. Those looking to use them for investment properties, however, will have to understand the restrictions inherent in the program.
First, beyond the requirement that the borrower possess a Certificate of Eligibility, the home must first and foremost be for his or her personal occupancy. However, that home can be an existing home or new construction, a condo or a residence with more than one unit. VA loans can also be used to make an existing home more energy efficient.
VA loans don’t come without other caveats. As with any government program, they’re wrapped in their fair share of red tape. For example, there are approximately 30 pages explaining the restrictions associated with the purchase of a home in a “common interest community,” or any residence that would have a common area (like a condo.) This doesn’t mean that VA loans can’t be used for condos, but be aware that lots of conditions will have to be met.
If you were hoping to use the property as a place to live and for a nonresidential purpose (for example a business downstairs, apartment upstairs), you’ll have to make sure that its main purpose is indeed residential. In fact, no more than 25 percent of the space can be used for anything other than that. There are also many other “minimum property requirements,” including stipulations that there be areas for living, sleeping, cooking and eating. That means that trying to pass off a retail space as an apartment isn’t going to work.
Stretching the Loan Amount
While the VA doesn’t put a limit on the amount of money you can borrow to finance your home, it does limit the amount of liability it will assume. For that reason, most lenders will limit the loan amount, which is generally four times what a veteran’s entitlement is. The basic entitlement is $36,000, but veterans in most of the country will be able to borrow an amount of $417,000 without a down payment. Keep in mind, though, that loan limits vary by county just as home values do.
The VA sweetens the deal by allowing any remaining entitlement to be used for another loan. So if you only used a portion of it for one home, part or all of the remainder can be used for your next purchase.
That may not sound too generous if you have only $25,000 of your entitlement left. But according to the VA, most lenders will only require that the guaranty entitlement and any down payment equal 25 percent of the value of the home. So you could still put no money down and use the remaining $25,000 entitlement to purchase a $100,000 home. Want a bigger loan? Make a larger down payment. See how far that money can stretch?
You can also have your entitlement restored if you’ve paid off the loan on a previously purchased home and you’ve sold that property, or if you sell a property with an existing loan to another service member who will use his or her entitlement to make the purchase.
What does all of this mean for the would-be real estate investor?
Veterans can use VA loans to acquire a starter home, enjoy living there for a time, then buy another home when they are ready to move while keeping the original as a rental property. That process can be repeated, as long as they have money in their entitlement.
Keeping in mind that “primary residence” requirement, VA loans offer especially exciting opportunities for flippers, if they’ll be occupying the property while it’s owned and perhaps updated. The financial advantages of VA loans make it easier for those without large cash reserves to maximize their profits on a flip. Since you can use your entitlement again and again, there’s really no limit to how many homes you can buy and sell at a profit. This may be a relatively slow way to build personal wealth, but it can be a substantial one.
Another exciting possibility lies in the fact that a VA loan can be used to purchase a property with more than one family unit, up to four. As long as you’ll be living in one of those units, you can rent out the others for additional income. What’s more, the VA will factor in the income from those units when determining the loan amount. This means that you could qualify for an even larger loan.
If you decide to purchase a property with another veteran, the number of units increases according to the number of purchasers – add one unit to the baseline of four for each additional purchaser. It also increases your buying power and entitlement.
Active military members can also use their basic housing allowance to seriously reduce or even eliminate monthly mortgage payments. That’s an advantage that most real estate investors simply don’t have.
If all of this has you saying “sign me up,” check the eligibility requirements to make sure you qualify. As with any type of loan, you’ll want to shop around with different lenders to get the best rate. You should also work with a broker who has VA loan experience and spend some time studying the program’s benefits and restrictions.
But even with those restrictions, VA loans are a powerful way for veterans without large cash reserves, whether new to the game or experienced investors, to build wealth from real estate, one property at a time.