By Douglas Katz – 03/02/23
Veterans Administration Home Loans (VA Loans) have long been a popular financing option for those looking to purchase a primary residence. However, what many people may not realize is that VA Loans can also be used to purchase properties intended for investment purposes. Before running headlong into using the VA loan to build your portfolio, there are some important things to know.
VA Loans in a nutshell
VA Loans are a benefit offered by the U.S. Department of Veterans Affairs to eligible active-duty service members, veterans, and surviving spouses. The loans are backed by the VA, which means that lenders are protected against losses if the borrower defaults on the loan. This allows lenders to offer favorable terms to borrowers, such as lower interest rates and no down payment requirements.
I have been lending for over two decades and I can definitively say that VA home loans are one of the consistently best residential loan programs in the marketplace. With recent improvements, veterans and active duty service members can obtain properties in excess on one million dollars with no down payment at a rate that beats the comparable conventional programs. When combined with the flexible guidelines for VA loans, borrowers typically that it is not only more economical, but easier for them as well.
Before going any further, however, I need to stress that investors interested in using VA for investment need to understand, accept and plan for limitations around the intended use for VA loans. VA loans are meant for primary residences – period. I say this not because they cannot be used for other purposes, but rather that there is very little flexibility when it comes to using a VA financed property. I get so many veterans with an intent to “hack” the VA system to build a massive investment empire using just VA. While it can help grow a portfolio, VA will not accomplish this.
Additionally, not all VA loans are created equal. Both lenders risk appetite and the borrower profile can impact the loan terms, so it is important to understand all of the moving parts if you intend to use VA as a tool in your investment strategy. Differences range from terms and eligibility and are based on things like service record and status, i.e. active duty vs reserve applicants. Additionally, the fee structure is different for disabled veterans, so a two different investors could see different economics on an acquisition based on disability status.
Advantages and Limitations
One of the most significant advantages of using a VA Loan to purchase an investment property is the lack of a down payment requirement. Unlike conventional loans, which typically require a down payment of at least 20%, VA Loans allow eligible borrowers to purchase a property with no money down. This can be a significant advantage for those looking to invest in real estate, as it frees up capital for other investments or expenses.
Another advantage of using a VA Loan for an investment property is the potential for favorable interest rates. VA Loans typically have lower interest rates than conventional loans, which can save borrowers money over the life of the loan. This can be especially beneficial for investment properties, which may have higher interest rates than primary residences.
However, there are some restrictions and limitations to using a VA Loan for an investment property. The VA requires that the borrower intends to occupy the property as their primary residence within 60 days of closing on the loan. This means that the borrower cannot use the property as a rental or vacation home immediately after purchase. However, the borrower may be able to rent out the property after occupying it as their primary residence for at least one year.
Additionally, the VA has a limit on the amount it will guarantee for a loan, which can vary depending on the location of the property. In some areas, the limit may not be enough to cover the full purchase price of an investment property. Borrowers may also be limited in the number of VA Loans they can have at any given time.
Overall, using a VA Loan for an investment property can be a smart financial move for eligible borrowers. However, it is important to understand the restrictions and limitations of the loan program and to consult with a knowledgeable lender and/or real estate professional to ensure that the investment is a sound one. The biggest thing to understand is the entitlement.
What is VA Entitlement?
The VA entitlement program is designed to assist veterans in purchasing and maintaining a home. If a veteran has used their VA entitlement to purchase a home, they may still be able to restore their entitlement in order to purchase another home in the future. VA entitlement is a guarantee from the Department of Veterans Affairs (VA) that they will pay a certain amount towards a home loan in the event that a borrower defaults on their loan. This guarantee is typically equal to 25% of the loan amount, up to a maximum amount that varies by county.
In recent years, the entitlement process has become more convoluted with different entitlement based on previous use and encumbered entitlement. Basically, think of entitlement as an allowable balance that each veteran has to apply to VA transactions. Each use reduces the available entitlement for future VA financed properties until entitlement is restored, which I will cover later. VA entitlement is not a loan, and it does not guarantee that a borrower will be approved for a home loan. Instead, it is a tool that lenders can use to help borrowers obtain favorable loan terms. Less entitlement means that the borrower will need to bring more of their own funds to the deal.
How to Restore VA Entitlement?
If a veteran has used their VA entitlement to purchase a home, they may still be able to restore their entitlement in order to purchase another home in the future. There is a lot of misinformation in the marketplace about the current process for restoring entitlement, so this is what investors need to get right.
There are several ways to restore VA entitlement, including:
- Paying off the original VA loan in full: If a veteran has paid off their original VA loan in full, they can restore their entitlement and use it to purchase another home.
- Selling the original home: If a veteran sells the home they purchased with their original VA loan, they can restore their entitlement and use it to purchase another home.
- Refinancing the original VA loan: If a veteran refinances their original VA loan and the new loan is not guaranteed by the VA, they can restore their entitlement and use it to purchase another home. Currently, VA borrowers can refinance and restore entitlement ONCE in their VA borrowing history. Future requirements are for a sale of the property and change of ownership. This is the part that investors think that they can “hack,” but usually find out the limitations are firm.
- Obtaining a restoration of entitlement: In some cases, veterans may be able to obtain a restoration of their entitlement from the VA. This is typically only available to veterans who have paid off their original VA loan in full and who have not used their entitlement to purchase another home.
The VA loan is awesome. I want to reiterate that because much of this article focused on the limitations which could be construed as a negative opinion. As I said, I think it is the single best program for veterans and active duty service members to obtain a primary residence. For investors it is not as simple. While still an amazing program, there are a lot of considerations to maximize the benefit and to elegantly work VA financed properties into a strategy. The best thing to do is always engage an expert in VA loans. You can get the guidelines yourself and I encourage doing so, but interpretation of and application of the guidelines is too important to DYI.