Chapter 42
Federal Housing Administration [FHA] and Veterans Administration [VA] Loan Programs
A. LOAN PROGRAMS OF THE FEDERAL HOUSING ADMINISTRATION (FHA)
INTRODUCTION
Besides conventional loans discussed in the previous chapter, FHA loans and VA loans are the other two major sources of home ownership financing in the United States. FHA loans are residential loans from private sector lenders that the Federal Housing Authority (FHA), a division of the U. S. Department of Housing and Urban Development (HUD), insures against financial loss to the lender should a borrower default on the loan payments. VA loans are residential loans from private sector lenders that the Veterans’ Administration (VA) guarantees against financial loss to the lender arising from a borrower’s default of the loan payments.
FHA INSURED LOANS
Congress established the Federal Housing Administration (FHA) in 1934 to encourage lenders to make real estate loans by providing them with government-backed insurance against financial loss from borrower default. The anticipated result of the legislation was the increase in home ownership that has occurred over these years. In addition to insuring lenders against financial loss from borrower default, the actions of the FHA over the years have led to lower downpayment requirements for borrowers, longer loan terms, positive amortization of the loan amount over the term of the loan, and more liberal loan qualification standards for the borrower. In 1965 the FHA became a part of the Department of Housing and Urban Development (HUD).
FHA’s threefold purpose is to assist in the stabilization of the mortgage market, to provide an adequate home financing system through its mortgage loan insurance program, and to promote improved housing standards. Toward these ends, FHA loans require an appraisal by an approved appraiser to confirm an adequate market value and to determine whether the buildings and neighborhoods involved meet the statutory standards. In order to fund the loan insurance program, the borrower must pay a premium for the FHA insurance (although sometimes the seller may pay the premium for the borrower).
Until December of 1983 the Secretary of HUD set the interest rate on FHA loans, a rate that was often lower than the prevailing market rate. For this reason, FHA allowed lenders to charge sellers discount points to compensate lenders for making FHA loans at the lower rates. HUD no longer sets FHA interest rates. Instead, negotiations between lenders and borrowers establish FHA interest rates; and the seller or borrower may agree to pay any discount points charged, as is the case in conventional loans.
THE FHA INSURES HOME LOANS
FHA does not make mortgage loans or provide housing. It only INSURES the mortgage loans made by private lenders, provided such loans meet FHA’s guidelines and obtain approval. Through the fees collected from FHA Mortgage Insurance Premiums (MIP), FHA is a self-supporting government agency. Most FHA loans are now made by or through a Direct Endorsement lender. To be approved by FHA for Direct Endorsement (D.E.), a lender must meet criteria established by FHA. After gaining FHA approval, the D.E. lender has the authority to approve purchasers and subdivisions without prior submission to FHA. If the D.E. lender chooses, it may hire a staff of appraisers to do all appraisals; or it may use FHA-approved fee appraisers.
FHA 203(b) LOAN PROGRAM
The FHA 203(b) loan program requirements and guidelines establish the basic characteristics that any FHA loan made by a private lender must possess. These features appear in the outline below.
| (a) | THE INTEREST RATE ON THE LOAN – In December, 1983 the Secretary of HUD ceased setting the maximum interest rate that lenders may charge on FHA loans. The rate is negotiable between the lender and the borrower. | ||||||||||||||||
| (b) | THE LOAN ORIGINATION FEE – The lender can charge a loan origination fee that does not exceed 1 percent of the loan amount. For this calculation, the loan amount does not include closings costs even if the borrower finances these costs. | ||||||||||||||||
| (c) | DISCOUNT POINTS – The lender can impose discount points, and the borrower and/or seller of the property can pay or share the discount in any proportion that they agree to in the contract. The amount of discount is the product of multiplying the discount points by the full amount of the loan including any financed closing costs. Before 1983 the FHA had mandatory restrictions against the borrower’s paying any discount points on the loan. If the lender was charging discount points, the seller had to pay the discount. The borrower could pay up to a 1 percent loan origination fee. |
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| (d) | THE BASIC AND THE MAXIMUM LOAN AMOUNTS – The 2011basic loan maximum for a single family residential unit is $271,050. However, in geographic areas in which housing costs are high, the maximum loan amount can exceed the basic loan maximum. This maximum loan amount depends upon the median home price in those “high cost” areas. The FHA calculates the maximum loan amount at 95 percent of the median house price in those areas. However, even in these high cost areas the maximum loan amount cannot exceed $625,500 at this time. Lenders who provide residential loans have current information about the maximum loan amount for their geographic area. FHA designates an area a high cost housing area after lenders or other interested parties in the area apply to the FHA and show evidence that the median sales price for houses sold in the preceding three months exceeds the basic loan amount. Those interested may follow the same procedure to request an increase in the existing maximum loan amount. By setting the maximum loan amount in the typical geographic area and the absolute maximum loan amount in areas with high-priced houses, the FHA loan program serves low and middle income households by focusing on low and moderate priced housing. The 2011 basic and the maximum FHA 203(b) loans for two, three and four unit properties appear in the following Exhibit. FHA loan limits for any county in the country can be found here. |
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| (e) | THE MORTGAGE INSURANCE PREMIUM – Every borrower under the FHA 203(b) loan program must carry insurance to protect the lender against financial loss. This insurance premium provides the financial base that the FHA uses to insure the lender against the possibility of the borrower’s default on the loan payments. The up – front mortgage insurance premium (UFMIP), which applies to all FHA loans, is paid in either of two ways — in cash at loan closing or financed over the term of the loan. The annual insurance premium relates to the loan-to-value ratio and the term of the loan. The annual premiums are for the term of the loan. |
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| (f) | THE MINIMUM CASH INVESTMENT – The minimum cash investment (similar to the downpayment) for an FHA 203(b) loan is typically lower than the downpayment for a conventional loan. In simple terms the FHA’s minimum cash investment is 3.5% while the typical conventional loan carries a downpayment of between 5% and 20%. In other words, the FHA loan-to-value ratio is approximately 96.5% while the loan-to-value ratio for a conventional loan is between 80 and 95%. The minimum cash investment is not the same as a downpayment because different funds are included in the calculation of the two figures. The downpayment is the difference between the sales price of the property and the loan amount. The minimum cash investment is the difference between the FHA’s base loan amount and the adjusted sales price which includes closing costs paid by the buyer, repair costs paid by the buyer, and the value of any sales concessions. | ||||||||||||||||
| (g) | FHA 203(b) LOAN CLOSING COSTS THAT CAN BE FINANCED – If the borrower pays closing costs, FHA allows him or her to include an estimate of “allowable closing costs” into the loan amount. The allowable closing costs are those closing costs customarily paid by the buyer. While local FHA lenders are the best source of information on the allowable closing costs in the area, typically, the buyer can finance the appraisal and the survey fees, the credit report charge, the 1 percent loan origination fee, title insurance costs, and the recording fees. The buyer cannot finance discount points, prepaid interest payments on the loan, or impound amounts for property tax and homeowner insurance as part of the FHA loan: | ||||||||||||||||
| (h) | THE FHA LOAN MUST BE THE SENIOR LOAN – The FHA requires that its loan be in the first or senior position in the financial package. | ||||||||||||||||
| (i) | JUNIOR OR SECOND LOANS – The FHA allows the borrower to obtain a second loan from another source in order to obtain the necessary funds to buy the property. However, FHA does not allow the borrower to obtain a second loan for the required downpayment or the closing costs on the FHA’s first or senior loan. | ||||||||||||||||
| (j) | PROPERTY TAX AND HOMEOWNER’S INSURANCE ESCROW ACCOUNTS – The FHA 203(b) loan program requires prepaid funds to establish the escrow account for property taxes and homeowners’ insurance. The buyer or seller can pay any or all of the settlement or closing costs customarily paid by the buyer. | ||||||||||||||||
| (k) | PREPAYMENT OF THE LOAN – The borrower has the full right of prepayment of the FHA 203(b) loan. He or she can pay it in full at any time, and the lender cannot impose a prepayment penalty for early repayment of the loan. | ||||||||||||||||
| (l) | THE FHA 203(b) LOAN IS ASSUMABLE – The FHA 203(b) loan is fully assumable. It does not contain a due-on-sale or an alienation clause. However, there are provisions for credit checks on the new borrower. | ||||||||||||||||
| (m) | FHA 203(b) INVESTOR OR NONOCCUPANT LOANS ARE NOT AVAILABLE – FHA stopped insuring loans to investors or nonoccupants of the property on December 15, 1989. However, an investor loan made before this date is still assumable if the new borrower meets the FHA’s current loan qualifying criteria. | ||||||||||||||||
| (n) | BORROWER QUALIFICATION STANDARDS – The qualifying standards for the FHA loan are less stringent than are the standards for a conventional loan. |
THE UP FRONT MORTGAGE INSURANCE PREMIUM (UFMIP)
An FHA borrower has two options for paying UFMIP. He or she can pay the entire MIP at closing or finance the entire amount. As of 2011, the UFMIP is 1.0% of the loan amount for a loan term greater than 15 years and 1.0% of the loan amount for a loan with a term less than 15 years. If the buyer finances the UFMIP, the premium plus the loan amount become the amount financed; and he or she must pay it over the term of the loan. The buyer, the seller or a third party may pay the entire UFMIP in cash at the closing.
THE ANNUAL INSURANCE PREMIUM
The borrower must pay an annual insurance premium in addition to the one-time mortgage insurance premium. The following table illustrates the annual premiums. The Annual Insurance Premium must be paid until the loan –to – Value Ratio becomes 78% or less.
Mortgage Insurance Premiums
Loans > 15 years
UFMIP = 100 bps
Annual Premium
LTV Through 4/17/2011* On/After 4/18/2011**
≤ 95.00 percent 85 bps 110 bps
> 95.00 percent 90 bps 115 bps
Loans ≤ 15 years
UFMIP = 100 bps
Annual Premium
LTV Through 4/17/2011* On/After 4/18/2011**
≤ 90.00 percent None 25 bps
> 90.00 percent 25 bps 50 bps
The loan-to-value ratio calculation to determine the annual premium is the FHA loan amount, not including the UFMIP, divided by the sales price or the appraised value of the property, whichever is the lesser amount.
INSURANCE PREMIUMS FOR FHA 234(C) CONDOMINIUM LOANS
An FHA234(c) condominium loan has a monthly insurance premium the same as the 203 b .
THE FHA 203(b) LOAN-TO-VALUE CALCULATION
The loan-to-value-ratio-calculation for the FHA 203(b) loan is approximately 96.5% and depends on the lower of the sales price or appraised value of the house. The borrower is required to invest the difference between the
(a) total acquisition cost (sales price, cost of any required repairs paid for by the borrower, and total closing costs to be paid by the borrower), and
(b) amount of the mortgage to be insured.
For a principal residence, the borrower’s minimum downpayment requirement must be at least 3.5% of the appraised value of the property or the sales price, whichever is less.
PROPERTIES ELIGIBLE FOR THE FHA SECTION 203(b) LOAN
FHA section 203(b) insured loans are available for the construction, purchase, or refinancing of a single to a four family housing unit.
QUALIFYING THE BORROWER FOR THE FHA SECTION 203(b) LOAN PROGRAM
The loan underwriting standards for an FHA section 203(b) loan are less restrictive than the standards for a conventional loan. The FHA standards attempt to make it easier for families with low to moderate incomes to qualify for a loan to buy a home.
The FHA qualifying standards rely on the estimates of “effective income,” “housing expenses,” and “fixed payments.” The concept of effective income includes the loan applicant’s gross income from all sources that will continue for at least the first five years of the loan term. This “effective income” concept is similar but not identical to the “stable monthly income” used to qualify a loan applicant for a conventional loan. For example, the FHA guidelines allow the loan underwriter to calculate the taxable income equivalent of any tax exempt revenue the loan applicant receives. Therefore, a tax exempt income of $400.00 per month for a person in the 15 percent tax bracket would be a taxable income equivalent of $470.00 because 85 percent of $470.00 is $400.00.
The definition of housing expenses in the FHA qualifying guidelines is similar to that for housing expenses in the guidelines for a conventional loan. However, the FHA housing expense ratio is higher at 29 percent. As with the conventional loan, housing expenses include the interest payment and the principal repayment, as well as the monthly real property tax and the monthly payment for homeowner’s or hazard insurance payment. Housing expenses can also include mortgage default insurance premiums, and homeowner’s or condominium association dues.
Fixed payments in the FHA qualifying guidelines are similar in some aspects, but different in others from the “total obligations” in the qualifying standards for a conventional loan. Fixed payments include the housing expenses as in the total obligations concept. Fixed payments also include all installment debts, revolving debts and other recurring financial obligations such as alimony, spousal support, and child support, but the definition of recurring debt is different. In the fixed payment concept recurring debt is any debt with more than six months remaining as well as any large debt even if it has less than six remaining monthly payments. This six-month period contrasts with the ten-month period for the conventional loan underwriting guidelines. In addition, fixed payments include child care expenses unless the loan applicant can show that no such outlays will occur. The FHA fixed payment ratio is 41 percent as opposed to the conventional loan’s total obligation ratio of 36 percent.
The FHA underwriting guidelines also allow for compensating factors that are similar to those for the conventional loan. The FHA identifies seven compensating factors:
| (a) | A large downpayment of at least 10 percent of the purchase price; | ||
| (b) | A strong potential for increased earnings based on education, job training, or employment history; | ||
| (c) | A substantial financial reserve equal to at least three monthly mortgage payments; | ||
| (d) | A history of carrying few debts and accumulating savings; | ||
| (e) | A history of allocating a higher than normal portion of effective income to cover housing expenses; | ||
| (f) | A large amount of short term income, such as a one-time capital gain or a royalty payment, that does not qualify as part of effective income; and | ||
| (g) | The property’s qualifying as an energy-efficient structure. |
OTHER FHA LOAN PROGRAMS
In addition to the 203(b) program, the FHA offers other programs. A list of these programs follow. Explanations of the adjustable rate mortgage program and the graduated payment program appear in the next chapter.
- 1. Section 203(b) Home Mortgage Insurance
- 2. Section 203(h) Home Mortgage Insurance for Disaster Victims
- 3. Section 203(i) Home Mortgage Insurance for Outlying Areas
- 4. Section 203(k) Rehabilitation Home Mortgage Insurance and Streamlined Limited Repair Program
- 5. Section 203(n) Single Family Cooperative Program
- 6. Section 220(d)(3)(A) Urban Renewal Mortgage Insurance
- 7. Section 220(h) Insured Improvement Loans Urban Renewal
- 8. Section 223(e) Miscellaneous Housing Insurance
- 9. Section 234(c) Mortgage Insurance for Condominium Units
- 10. Section 238(c) Mortgage Insurance in Military Impacted Areas (MIAs)
- 11. Section 245(a) Graduated Payment Mortgages (GPMs) and Growing Equity Mortgages (GEMs)
- 12. Section 247 Single Family Mortgage Insurance on Hawaiian Home Lands (HHL)
- 13. Section 248 Single Family Mortgage Insurance on Indian Lands (IL)
- 14. Section 251 Adjustable Rate Mortgages (ARMs)
- 15. Section 255 Home Equity Conversion Mortgage (HECM)
For complete information on all these programs click here.
PROCESSING THE FHA LOAN
The FHA has two methods for processing loans. The first method is “direct endorsement” processing. In this method, HUD authorizes lenders to issue FHA loan commitments without prior submission of individual loan applications to HUD. The second loan processing method requires a lender to submit paperwork to HUD prior to approval of the property and prior to HUD approval of the individual.
An applicant for an FHA loan initiates the loan procedure by submitting a loan application to a FHA-approved lending institution. The lender orders an appraisal of the subject property to establish the market value of the property and to provide a list of physical deficiencies in the property. The seller must correct these deficiencies or “immediate repair items” before FHA can grant approval of the loan. For properties that meet the eligibility standards, the FHA issues a conditional commitment identifying the appraised market value of the property and the amount of the insurance the FHA will grant. The loan applicant then formally applies for a loan with an FHA approved lender, who sends the application and financial information about the borrower to the FHA. If the FHA approves the loan application, it will issue an insurance commitment to the lender.
FACTS ABOUT AN FHA APPRAISAL
As the on-site representative for the lender, the appraiser provides preliminary verification that a property meets the General Acceptability Criteria, which include the Minimum Property Requirements (MPR) or Minimum Property Standards (MPS).
| (a) | CONDITIONAL COMMITMENT – The purpose of an FHA appraisal is to determine the property’s reasonable value, which in turn sets the maximum mortgage available. The conditional commitment certifies FHA acceptance of the property but notes any repairs necessary to meet FHA Minimum Property Requirements. An FHA appraisal should be ordered through a mortgage lender who will in turn request the appraisal. Either the purchaser or seller may pay the FHA appraisal fee but they must pay it in advance and under no circumstances can a mortgage lender extend credit for the appraisal to either purchaser or seller. A conditional commitment is valid for six months on existing properties and 12 months for proposed construction. |
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| (b) | THE CONDITIONAL COMMITMENT AND THE SALES CONTRACT – If the FHA issues the Conditional Commitment after the date of the sales contract and the appraisal value is less than the sales price in the contract, the purchaser has four options available. | ||
| (1) | He or she may request a return of his or her earnest money since an FHA sales contract must be contingent upon the appraised value’s being at least as much as the sales price. | ||
| (2) | The purchaser may pay the difference in cash. If the purchaser wishes to buy the property for more than the appraised value, he or she may do so by paying the difference between the sales price and appraised value in cash at the time of closing. | ||
| (3) | He or she may renegotiate with the seller. Perhaps the most practical alternative is to renegotiate with the seller for a lower sales price based on the Conditional Commitment. While it is possible for the purchaser to pay more than the appraised value, it is unusual. The seller of course may refuse to renegotiate price, and the transaction would then terminate. | ||
| (4) | The parties may ask for reconsideration of the Conditional Commitment. If a party to the transaction feels the Conditional Commitment is too low in its estimate of value and has sufficient evidence in the form of comparable sales, FHA will reconsider the appraised value. FHA requires the following information for three comparable properties located in the same general area as the subject property before they will reconsider the appraised value: (a) the location & legal description; (b) the sales price & date of sale; (c) the square foot area; (d) the number of rooms; (e) the number of bedrooms & baths; (f) the type of heat; (g) the exterior construction; (h) the age & condition; (i) any garage & carport; (j) any amenities that tend to add value; and (k) a firm sales contract, if applicable. | ||
An FHA appraisal assumes that the property is in its repaired condition. Therefore, a seller who is willing to accept FHA financing may want to make necessary repairs prior to the appraisal.
APPRAISAL GUIDELINES FOR FHA ELIGIBLE PROPERTIES
FHA insured loans are available for a wide range of housing meeting the FHA’s minimum property requirements. For appraisal purposes, FHA classifies each property eligible for an FHA insured loan in one of the following categories:
| (a) | PROPOSED CONSTRUCTION – Mortgage lenders and real estate brokers are good sources of information on specific requirements for property to be built under FHA specifications. | ||
| (b) | EXISTING PROPERTY LESS THAN ONE YEAR OLD – Normally, FHA will issue a Conditional Commitment on property less than one year old only if it has been built by an FHA approved builder and has a 10-year warranty although there can be exceptions. | ||
| (c) | EXISTING PROPERTY OVER ONE YEAR OLD – This classification has requirements in two primary areas. | ||
| (1) | The seller must complete all repairs listed on the Conditional Commitment, and FHA must approve the repairs prior to closing the loan. To avoid any obligation for the licensee to pay the cost of the seller’s repairs, it is good business practice to let the seller order all repairs. | ||
| (2) | The Conditional Commitment entitles the purchaser to a copy of a letter certifying that the house is free of wood infestation and requires that the seller repair any known wood infestation damage before closing. | ||
B. THE VETERANS ADMINISTRATION (VA) LOAN PROGRAM
VA GUARANTEED LOANS
The Serviceman’s Readjustment Act of 1944, also known as the GI Bill of Rights, established The Veterans Administration as an independent agency of the Federal Government to offer assistance to the veterans or their surviving spouses. As part of that assistance, the VA loan program aids veterans in obtaining home financing.
The Veteran’s Administration (VA) guarantees the repayment of loans made by private lenders to qualified veterans to purchase or to construct homes. It also offers the guarantee for loans to refinance an existing mortgage even if the existing mortgage is not a VA loan. The guarantee takes effect only upon default and foreclosure of the veteran’s property and protects the lender against a portion of the financial loss that could arise from the difference in the foreclosure sales price and the loan amount. The VA establishes the amount of its guarantee.
The program covers owner occupied single-family houses and multifamily structures of up to four units, although the veteran must occupy one of the units in the multifamily structure. This program enables veterans to obtain loans through lending institutions with little or no down payment. Although the VA has no established limit on the amount of the loan, it does guarantee only a fixed percentage of the entire amount.
THE VA LOAN GUARANTEE
Public Law 110-389, the Veterans’ Benefits Improvement Act of 2008, signed October 10, 2008, provided a temporary increase in the maximum guaranty for loans closed January 1, 2009 through December 31, 2011. The maximum guaranty now varies depending on the location of the property. While VA does not have a maximum loan amount, there are effective “loan limits” for high-cost counties. The limits are derived by considering both the median home price for a county and the Freddie Mac conforming loan limit. To aid lenders in determining the maximum guaranty in high-cost counties, VA has created a Loan Limit chart, with instructions. This will be updated yearly.
In general, maximum guaranty, assuming the veteran has full entitlement, is as shown in the table below.
| Loan Amount | Maximum Potential Guaranty | Special Provisions |
| Up to $45,000 | 50 percent of the loan amount. | Minimum guaranty of 25 percent on IRRRLs. |
| $45,001 to $56,250 | $22,500 | Minimum guaranty of 25 percent on IRRRLs. |
| $56,251 to $144,000 | 40 percent of the loan amount, with a maximum of $36,000. | Minimum guaranty of 25 percent on IRRRLs. |
| $144,001 to $417,000 | 25 percent of the loan amount | Minimum guaranty of 25 percent on IRRRLs. |
| Greater than $417,000 | The lesser of:
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Minimum guaranty of 25 percent on IRRRLs |
The VA does not set a maximum loan amount nor a maximum sales price or value for the house. The veteran can buy a house valued at more than $417,000.00 but will have to provide the difference as a downpayment. In the event of after a foreclosure, the VA may elect (1) to have the lender sell the property and then pay the lender any resulting loss, up to the limits of liability, or (2) to pay the lender and market the property itself. If it chooses the second alternative, the VA will then typically work with local brokers and offer attractive financing for potential purchasers.
VA LOAN CHARACTERISTICS
The VA loan guarantee program requirements dictate many of the provisions that the loan agreement between the borrower and lender must possess. The following subsections outline and discuss these requirements.
| Subject | Explanation | |||
| Maximum Loan Amount | VA has no specified dollar amount(s) for the “maximum loan.” The maximum loan amount depends upon:
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| Downpayment | No downpayment is required by VA unless the purchase price exceeds the reasonable value of the property, or the loan is a Graduated Payment Mortgage (GPM). The lender may require a downpayment if necessary to meet secondary market requirements. | |||
| Amount of Guaranty | Guaranty is the amount VA may pay a lender in the event of loss due to foreclosure. | |||
| Occupancy | The veteran must certify that he or she intends to personally occupy the property as his or her home. |
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| Subject | Explanation | |
| Interest Rate and Points | Interest rate and points are negotiated between the lender and veteran.
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| Purpose of Guaranty | To encourage lenders to make VA loans by protecting lenders/loan holders against loss, up to the amount of guaranty, in the event of foreclosure. | |
| Underwriting | Flexible standards. The veteran must have:
– stable income |
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| IRRRLs (Streamline Refinancing Loans) | Used to refinance an existing VA loan at a lower interest rate.
Note: A fixed rate loan to refinance a VA Adjustable Rate Mortgage (ARM) may be at a higher interest rate. |
Funding Fee Tables
Purchase And Construction Loans
| Type of Veteran | Downpayment | Percentage for First time Use | Percentage for Subsequent Use | |
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Regular |
None |
2.15% |
3.3% * |
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Reserves/ |
None |
2.4% |
3.3% * |
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| Funding Fee | The veteran must pay a funding fee to help defray costs of the VA home loan program.
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| Closing costs | Those payable by the veteran are limited by regulation to a specific list of items plus a one percent flat charge by the lender.
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| Security Instruments | The lender may use any note or mortgage forms they wish as long as they contain certain VA-required clauses, samples of which may be found at: http://www.homeloans.va.gov/lenderssampdocs.htm | |||
PROPERTIES ELIGIBLE FOR THE VA LOAN
VA guaranteed loans are available for the construction and purchase of an owner occupied single-family to four-family structure.
PROCESSING THE VA LOAN
The VA uses two methods for processing its loans: prior approval processing, and automatic processing. In the prior approval loan processing method, the lender takes the loan application, requests VA to appraise the property, and verifies the loan applicant’s income and credit history. The lender sends a loan package containing this information to the VA for review. If the VA approves the loan package, it sends the lender a commitment to guarantee the loan. The lender closes the loan and sends a report of the closing to the VA. If the final loan arrangement complies with VA requirements, the VA issues a certificate of guaranty to the lender.
In the automatic processing method, the lender orders a property appraisal from the VA, but has the authority to make the credit decision without the VA’s prior approval. Under either method, the applicant must prove that he or she is eligible for the VA program by securing and completing a “Request for Determination of Eligibility and Available Loan Guarantee Entitlement” form. This form is available from the VA or most lenders. The lender sends the completed form to the VA along with the veteran’s separation papers from the military. The VA then issues a certificate of eligibility.
QUALIFYING THE BORROWER FOR A VA LOAN
The loan underwriting standards for a VA loan are generally less restrictive than the standards for both a conventional loan and the FHA section 203(b) loan (The VA standards make it easier for all veterans, especially those with low to moderate incomes, to qualify for a loan to buy a home.
The borrower qualification criteria for a VA loan involve the use of two different methods — the total obligations ratio and the cash flow analysis. The veteran must qualify under both methods.
| (a) | THE TOTAL OBLIGATIONS RATIO – The total obligations ratio for the VA loan is the same as the total obligations ratio for the FHA section 203(b) loan. Effective income and the total obligations are estimated in the same manner, and the value of the ratio is at the same current level of 41 percent. | ||||||||||||||||||||||||||||||||||||||||||
| (b) | CASH FLOW ANALYSIS – The first step in the cash flow analysis is the calculation of the veteran’s “residual income.” Residual income is gross monthly income reduced by the following items: | ||||||||||||||||||||||||||||||||||||||||||
| (1) | estimated housing expenses for the property being considered, estimated in the same manner as they are for the FHA loan. | ||||||||||||||||||||||||||||||||||||||||||
| (2) | all recurring financial obligations as in the FHA total obligations calculation; | ||||||||||||||||||||||||||||||||||||||||||
| (3) | federal, state and local income taxes; and | ||||||||||||||||||||||||||||||||||||||||||
| (4) | social security tax, Medicare tax, and any other taxes deducted from the veteran’s paycheck. | ||||||||||||||||||||||||||||||||||||||||||
Any remaining income, the residual income, must be at least one dollar greater than the minimum residual income requirements shown in the following tables. The VA bases the minimum requirement on the size of the proposed loan, the size of the veteran’s family, and the location of the property in the US.
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The VA qualification standards set out in the total obligations ratio and cash flow residual income analysis are merely guidelines for the loan underwriter. The VA identifies a list of compensating factors that a loan underwriter can consider if the veteran does not meet the standards for either one or both of the underwriting methods. These factors are the following:
| (a) | making a downpayment when none is required; | |
| (b) | having a high residual income when the total obligation ratio exceeds 41%; | |
| (c) | showing a low total obligations ratio when the residual income level is too low; | |
| (d) | demonstrating an excellent, long-term credit history; | |
| (e) | having a history of stable long-term employment; | |
| (f) | proving a conservative use of consumer credit evidenced by a low level of debt ; |
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| (g) | possessing a significant level of savings and liquid assets; and | |
| (h) | demonstrating a satisfactory history of home ownership. |
The VA specifically identifies a tradeoff relationship between a high total obligations ratio and a residual income level. If the total obligations ratio exceeds 41 percent and if the residual income is at least 20 percent above the required minimum, the underwriter can approve the loan without consideration of any other compensating factors.
FACTS ABOUT VA APPRAISALS
The property which serves as security for a VA loan must meet housing standards set by the VA. An appraiser approved by the VA must perform an appraisal to determine property acceptability, reasonable value, and necessary repairs to the property, if any, required to meet those standards.
| (a) | NOTICE OF VALUE (NOV) – The VA appraisal report, called “Notice of Value (NOV),” sets forth a market value that establishes the maximum 100% loan that VA will guarantee on the property. The lender requests this NOV in writing, and either the purchaser or seller may pay the fee in advance. Under no circumstances can a lender extend credit for the NOV to either purchaser or seller. | |
| (b) | VALIDITY PERIOD – A NOV is valid for six months on existing properties and 12 months for proposed construction. |
THE CRV AND THE SALES CONTRACT
If the VA issues the NOV after the date of the sales contract and the appraised value is less than the sales price in the contract, the veteran purchaser has the following options available:
| (a) | REQUEST A RETURN OF HIS OR HER EARNEST MONEY – The VA sales contract must be contingent upon the value in the NOV being at least as much as the sales price. If the value is less than the sales price, the purchaser is due a refund of the earnest money. | ||
| (b) | PAY THE DIFFERENCE IN CASH – If the veteran wishes to buy the property for more than the appraised value, he or she may do so by paying the difference between the sales price and the appraised value in cash at the time of closing. However, the veteran may NOT under any circumstances obtain a second mortgage at the time of taking out a new VA loan when the sales price exceeds the appraised value. | ||
| (c) | RENEGOTIATE WITH THE SELLER – Perhaps the most practical alternative is to renegotiate with the seller a lower sales price based on the NOV. While it is possible for the purchaser to pay more than the appraised value, it is unusual. Of course, the seller may elect not to renegotiate and cancel the contract. | ||
| (d) | REQUEST RECONSIDERATION OF THE NOV – If a party to the transaction feels the NOV is too low in its estimate of value and has sufficient evidence in the form of comparable value, VA will reconsider the appraised value. The VA requires the following information for three comparable properties located in the same general area as the subject property before the VA will reconsider the appraised value: (1) the location & legal description; (2) the sales price & date of sale; (3) the square foot area; (4) the number of rooms; (5) the number of bedrooms & baths; (6) the type of heat; (7) the exterior construction; (8) the age & condition; (9) any garage or carport; (10) any amenities that tend to add value; and (11) a firm sales contract, if applicable. |
A VA appraisal assumes that the property is in its repaired condition. Therefore, a seller amenable to selling a home under VA financing may want to make necessary repairs prior to the NOV.
APPRAISAL GUIDELINES FOR VA ELIGIBLE PROPERTIES
In keeping with VA’s policy to see that the loan program is of real benefit to the veteran, a wide range of housing will qualify as security for VA guaranteed loans, provided each unit meets VA property standards. Single family (freestanding) homes, condominiums, and multifamily properties are eligible for VA loans. For appraisal purposes, the VA places each eligible property in one of the following categories:
| (a) | PROPOSED CONSTRUCTION – Lenders and real estate brokers are good sources for information on VA property requirements for proposed construction. | ||
| (b) | EXISTING PROPERTY LESS THAN ONE YEAR OLD – Normally, VA will issue a NOV on property less than one year old only if an FHA or VA approved builder built it and it has a warranty such as a HOW warranty. There are exceptions to this procedure. | ||
| (c) | EXISTING PROPERTY OVER ONE YEAR OLD – This classification has requirements in two primary areas. | ||
| (1) | Repairs ‑ The seller must pay for and complete all repairs listed on the NOV, and the VA must approve the repairs before closing the loan. To avoid any obligation for the licensee to pay the cost of the seller’s repairs, it is good business practice to let the seller order all repairs. | ||
| (2) | Wood Infestation ‑ The veteran must receive and acknowledge receipt of a copy of a letter certifying that the house is free of wood infestation, and the seller must repair and pay for any known wood infestation damage. If the seller refuses to pay for the repairs, he or she has the option of not selling. | ||