VA construction loans vs VA rehab loans
Posted on: October 29, 2019
You may have heard that VA construction loans are rare, and it’s true that these loans aren’t common. But, VA construction loans do exist and qualified borrowers can apply their VA entitlement bonus to a new construction mortgage.
But, before you go looking for a lender to provide a VA construction loan, consider the VA rehabilitation loan, which may be more suited for your project needs — and easier to find. A VA rehab loan can be used to finance a fixer-upper or make improvements to your existing property.
What is a VA construction loan
A typical consumer construction project requires three loans. The first buys the land. The second pays for construction. And the third is a mortgage that repays those first two loans once the home’s finished.
The goal of a VA construction loan is to provide a single loan that replaces those three. It allows you to buy the land and pays your construction costs in phases as progress is made. And, once the home is complete, you don’t need a new mortgage because your VA loan is already in place.
It’s a great idea. If you can find one.
You must use a licensed, insured builder
It’s important to note that you can’t use one of these loans for a self-build project, even if you are a skilled amateur. According to the VA:
“… you will need a licensed, insured builder that is willing to submit documentation to become an approved builder. The VA program does not allow for owner/builders. While the VA only requires that the builder be registered to participate in the program, each lender can require the builder to go through an approval process.”
Your builder will also have to take on more financial responsibilities than is normal. So you need to make sure the builders you speak to know what they’re getting into before you waste too much time. Best to show them the VA’s brief overview of what’s involved.
Building a new home with a VA construction loan
You’re eligible for a VA loan and have the necessary entitlement. You find a perfect site that’s VA-compliant (see the department’s new minimum property requirements for details). You put together great plans, specs, and schedules that are both VA- and local authority-compliant. Your contractor’s VA-registered. You apply for a VA construction loan.
And, you’re turned down — repeatedly.
Why VA construction loans are hard to get
With a VA construction loan the VA only guarantees part of your loan. You’re actually borrowing from a private lender. And those private lenders are entitled to set their own standards and requirements, above and beyond the VA’s.
The fact is a majority of VA lenders believe construction projects carry too much risk and involve too much hassle. So they’d rather pass on the loan than help you.
VA construction loan lenders
The VA construction loan is rare, not extinct. Below is a list we compiled of mortgage companies that advertise offering construction loans. (We aren’t affiliated with any of these companies nor have we evaluated them. Do your research before reaching out)
- AFR Wholesale. American Financial Resources is a “wholesale lender,” which means you can’t borrow from it directly. Instead, you need to find a mortgage company that is willing to use this wholesaler. AFR Wholesale says that it offers 100% financing on construction loans, requires a minimum 620 credit score, and no payments are required during construction.
- Bank of England Mortgage. A part of a locally owned community bank in England, Arkansas, it states it provides 100% financing for construction loans and no payments are required during construction similar to AFR.
- Security America Mortgage. This Texas-based lender says it offers 100% financing and requires no payments during construction.
- VA Nationwide Home Loans. This is a division of Magnolia Bank. It says it offers 100% financing on these loans, with a minimum credit score of 620, and it funds through the construction phase.
Remember — it’s up to you to check these out.
What are the interest rates for construction loans?
The VA does not set interest rates for any type of VA-guaranteed mortgage. VA construction loan interest rates will vary based upon the lender. As with any mortgage, borrowers should shop around to find the best rate.
Do I need a certificate of eligibility (COE) for a construction loan?
Yes, you will need a copy of your current COE. In most cases, the lender can obtain this for you quickly and easily.
Alternatives to a VA construction loan
There may be a couple of other options if you hit a wall trying to find a lender that offers VA construction loans. They involve your using savings or further borrowing to get you through until the home is mortgageable.
The obvious route is the conventional one described above. This involves separate loans for buying the land, construction costs, and paying down the first two. You’ll likely need a significant down payment for one of two of the loans.
A second possibility is to get a “one-time close mortgage” backed by the Federal Housing Administration (FHA). This does much the same job as a VA construction loan. There are a couple of drawbacks. One, it requires a minimum down payment of 3.5% of the loan amount. Two, once you start paying down your mortgage, you’re going to pay mortgage insurance every month.
As soon as your home’s finished, you can refinance your FHA loan to a VA one. And, you can refinance 100% of the home’s market value, so you could get your FHA down payment back. Better yet, your one-time funding fee will eliminate your mortgage insurance payments.
Buying a fixer-upper with a VA rehab loan
If you’re looking to purchase an existing home and fix it up, there are financing options available to you more accessible than a VA construction loan.
VA rehab loan
A VA rehabilitation loan works a lot like a VA construction loan. But instead of building a home from scratch on a virgin plot, you buy an existing home and improve it under one loan.
Unfortunately, they share some of the downsides of those construction loans:
- They’re perhaps a bit easier to find than construction loans but they’re still not common.
- You must use a VA-registered contractor.
- The renovated home must comply with the VA’s minimum property requirements.
- Although the VA no longer imposes loan limits on rehab loans, your lender might.
- You can’t borrow more in total than 100% of the likely appraised market value of the home, once work is completed, including the purchase price.
You’re perhaps a bit less likely to hit a wall with a rehab loan. But you still might.
OVM Financial says it’s an independent retail mortgage lender serving Virginia, North Carolina, South Carolina, Georgia, Tennessee, Maryland, Florida, Colorado, and Texas. Its website promises, “… any VA qualified buyer or homeowner could obtain our VA renovation loan just like a traditional VA loan.” Again, we haven’t evaluated this lender, so you should make sure you do your research.
FHA 203(k) rehab loans
FHA 203(k) rehab loans also enable homebuyers to roll the financing for the purchase of a house and the cost of improving it into a single mortgage. As with FHA One-Time Close Construction Loans, these can be refinanced into a standard VA loan once construction on the home is complete. Again, you’ll need a minimum 3.5% down payment for the FHA loan.
If all you want to do is improve the energy efficiency of the home you are buying, you may be eligible for an Energy Improvement Mortgage (EIM). EIMs allow borrowers to include the cost of energy-efficiency improvements in the mortgage for an existing home without increasing the down payment. EIMs allow the borrower to credit the money saved in future utility bills toward financing energy improvements.
EIMs are a type of Energy Efficient Mortgage, which broadly describes financing intended to give borrowers the opportunity to finance cost-effective, energy-saving improvements. Both EEMs and EIMs typically require a home energy rating that provides the lender with anticipated monthly savings.
Financing renovations on your existing home
It’s much easier to finance fixing up a home you already own than one you’re buying. Of course, you still won’t be able to borrow more than 100% of the appraised market value of your home. But, if you have equity, you’ll likely be able to get a VA cash-out refinance. You can spend some or all of the proceeds of that loan on home improvements.
For a VA cash-out refinance, you’ll have to qualify for the loan like you did with your purchase loan — income documentation, appraisal, and a minimum credit score. Most lenders are happy with a minimum credit score of 620 or higher, though some will consider lower.
For energy efficiency improvements to a home you already own, you may be eligible for an Energy Efficiency Mortgage (EEM), which credits anticipated energy savings into your refinance. You can probably avoid the hassle and cost of a full cash-out refinance and instead, do a VA streamline refinance (aka interest rate reduction loan or IRRRL).
What types of renovations can be made using the Energy-Efficiency Improvement program?
Any improvement that leads to the reduction in energy costs can be considered from caulking the windows to new attic insulation.
Next steps for a VA construction or VA rehab loan
There is no central list of lenders who issue VA home loans. And, everyone’s home buying needs are different. The best way to find the right loan and lender for you is to shop around and compare rates from multiple lenders.