With the housing market as hot as it is now, finding the perfect house is no easy task.
Those who want to skip the house-hunting competition, or simply want a home tailor-made to their needs, might consider building a house from scratch with a construction loan.
Conventional construction loans tend to have greater down payment requirements and higher interest rates than mortgages for existing homes. But veterans could be able to bypass some of those drawbacks with a VA (U.S. Department of Veterans Affairs) construction loan.
“VA limits closing costs, and the VA home loan guaranty means competitive interest rates. These cost savings can amount to tens of thousands of dollars over the term of the mortgage,” says Jeffery London, executive director of the Loan Guaranty Service at the U.S. Department of Veterans Affairs.
What Is a VA Construction Loan?
A VA construction loan is a loan to finance the construction of a new home build. It is issued by a private lender but backed by the VA.
Construction loans come in different forms. Because construction-only loans are short-term, high-interest, and designed for home construction, many homeowners opt for a construction-to-permanent loan, which restructures the construction loan into a regular home mortgage after the home is built. This is also known as a one-time close construction loan.
“A one-time close VA construction loan combines the two loans with a single application and closing, and a two-time close loan has two separate processes for the construction and mortgage phases,” says Andrina Valdes, COO of Cornerstone Home Lending, Inc.
VA loans can be used as one-time loans, but you may have to check with a few lenders before you can find one that’s willing to finance the build and mortgage of your home.
For the best results, look for lenders and contractors who have plenty of experience with VA construction loans.
In some cases, this process can require two different lenders. So veterans may choose a VA construction-only loan, then roll that loan into a VA loan for the mortgage.
How Does a VA Construction Loan Work?
Because VA construction loans are partially guaranteed by VA, they’re lower risk for lenders, which benefits borrowers.
“In most cases, no down payment is required by VA for VA loans. No private mortgage insurance (PMI) is required by VA, so the cost savings is considerable for those using the VA home loan program,” says London.
Instead, VA loans require an upfront funding fee. The fee varies depending on the down payment, as well as if you’ve used a VA loan before. Funding fees can range from 1.65% to 3.6%.
“You’ll also need to submit your construction plans when you apply for the loan,” adds Valdes. The lender will look at those plans, along with your finances, when deciding whether to issue you the loan. The appraiser will also perform the appraisal based on the construction plans rather than an existing house.
To be eligible for a VA loan, you must be a current or former U.S. Military service member. Families of service members may be eligible in some cases.
“Service members and Veterans qualify for the VA home loan benefit based on meeting the requirements for character of discharge and service time. The first step for any Service member or Veteran is to obtain their Certificate of Eligibility (COE) from VA, which the borrower can do themselves or acquire through the lender of their choice,” says London.
The official VA website has the full list of requirements, as well as an online application for a COE (Certificate of Eligibility).
Aside from the VA eligibility requirements, you must also be approved by the lender, like you would for other home loans. The requirements will change depending on the lender, but general requirements for most lenders include:
- Personal credit. The lender will have an ideal credit score in mind for borrowers. But because the loan is backed by VA, you might not need quite as good of a score as you would with a conventional loan.
- Debt-to-income ratio. This figure tells lenders how much of your gross monthly income is already allocated to your existing debt. Many lenders look for a DTI ratio that’s under 45% for VA loans.
- Income and employment. Most lenders want to see you employed in the same line of work for a few years, which tells them you have job security. Your income will also be a factor in the amount you can borrow. It’s always good to get a sense of how much house you can afford based on your income before starting the mortgage process.
How to Find a VA Construction Loan Lender
Finding a lender who works with VA loans and willing to underwrite a VA construction loan may take time.
“Definitely look for a lender that has experience with VA loans – and ask for some examples/numbers verifying their ability to close them on time,” says Valdes.
A good place to start is your local VA regional office. VA has offices all over the country, and they may be able to assist you with information on lenders who work with VA loans in your area.
How to Get a VA Construction Loan
The exact steps you’ll take to get a VA construction loan will depend on the lender, your financial situation, and the building project. Here are a few of the basic steps you can expect to follow:
- Confirm eligibility with VA and apply for a Certificate of Eligibility (COE). Before planning your home, make sure you’re eligible for a VA loan. You’ll also need to apply for a Certificate of Eligibility (COE) to show your lender that you’re qualified. You can find the full list of eligibility requirements, as well as an online application for the COE, on the official VA website.
- Find a lender and a builder. After you’ve received your COE, you’ll need to find a lender and a builder to work with. It’s a good idea to use lenders and contractors familiar with the VA loans process. This is especially important due to the higher risk and complexity of using a VA loan for construction purposes. If you don’t already own the land you plan to build on, you may need to secure separate financing for the land purchase.
- Submit plans and timeline for approval. Once you’ve found a suitable lender who will agree to financing a VA construction loan, the building plans, budget, timeline, and the contractor you use will all need to be approved by the lender. The lender also checks your personal finances to make sure you can pay back the loan amount. This approval process can take some time to complete.
- Get home appraisal based on the plans. Unlike with a regular mortgage, the house that needs to be appraised does not yet exist. So, the appraiser will perform the appraisal based on the proposed construction plans provided by your builder.
- Close the loan and start building. If you’re approved, your lender will look to the timeline as a guide for disbursing the loan funds to your contractor as needed. While your home is being built, you’ll pay interest on the construction loan. Once the construction is finished, you’ll enter the repayment period for the construction loan, or the loan can be restructured into a traditional mortgage.
Pros and Cons of a VA Construction Loan
No minimum down payment required
No mortgage insurance required
Upfront funding fee (waived in some cases)
Lenders can be hard to find
Must apply for and receive a Certificate of Eligibility (COE)
Should You Get a VA Construction Loan?
Due to the favorable terms that come with VA loans, this is a good option to pursue for home construction, as long as you can meet the VA home construction loan qualifications.
With no mortgage insurance, VA loans often cost borrowers less. But lenders who offer VA loans can be hard to find, especially if construction is involved.
“Don’t be afraid to interview multiple lenders and find someone you really flow with—someone who is on the ball, and answers your calls and questions quickly,” says Chris Roberts, loan officer at Loan Simple, Inc. in the Denver area.
If you have good credit and enough saved up for a down payment, you might qualify for a standard construction loan with comparable terms. While VA loans offer financial benefits, there’s more paperwork and eligibility requirements. Making the best choice on the loan—and the lender—means keeping the overall picture in mind.