As discussed in a previous post, VA home loans provide a host of benefits for those who are eligible. Though VA loans do not require a down payment, there are still closing costs involved that can put a financial strain on homeowners. This is very similar to the concept of buying a car. If you finance 100% of the purchase price of the car, you still have to pay the DMV registration, get car insurance, etc. Understanding the nature of VA closing costs can help active servicemen and veterans better account for the actual costs associated with purchasing a home. There are also options available to receive closing cost assistance from lenders, real estate agents and sellers.
A common falsehood that is brought up in conversations about VA loans is that such loans do not involve closing costs. Anytime someone purchases a home whether they pay cash for a home or obtain a mortgage loan they will have closing costs. In terms of a VA mortgage loan they are really focused into four categories
VA Funding Fee
Among other closing costs such as appraisal fees, title fees, inspection fees, and prepaid items like insurance premiums, perhaps the most significant closing cost is the VA Funding Fee. This fee directly supports the VA’s operations, and it can account for 1.25 – 3.3% of the loan amount. For veterans who are disabled to a certain degree, this fee may be waived if you have a disability rating of 10% or great. Now this is the ONLY item that can actually be rolled into the loan amount itself. No other costs when making a home purchase can be rolled into the loan amount
Where the funding fee benefits the VA, the origination fee provides compensation to the lender. Now most lenders only pass along the fees of the costs they incur to originate the loan. These include fees like the credit report fee, underwriting and appraisal inspection fee. Now a few top originators in the country like Brian Decker actually apply their compensation to cover these items for their clients.
Discount points are used to purchase a lower interest rate. These are kept separate from the origination fee because discount points do not go to the lender. Most lenders advertise interest rates with discount points in their online advertising, which is very misleading to veterans. This is because the rates shown with discount fees are lower than market interest rates and very few veterans actually have the funds on hand to spend thousands of dollars on top of their closing costs to obtain these rates
Third Party Fees
The process of securing a home loan requires additional activity conducted by third parties. These parties in most States are selected by either the seller or listing agent. These costs are traditionally the highest cost to the veteran out of pocket. These include fees like title company fees, escrow company fees, notary signing fees, inspection fees and County/State fees. These will vary greatly State to State. In a State like California these costs are traditionally about .75% to 1% of the purchase price to each party of the transaction (buyer and seller).
Prepaids are monies owed at closing for RECURRING costs of homeownership. These include items like your property tax installment (usually the prepayment of 6 months of property taxes), homeowners insurance annual premium, first month’s mortgage interest payment and 1 to 2 months of HOA dues (if there is a HOA) (usually 1.25-1.75% of the purchase price depending on the State. These are not closing costs in the sense they are not fees, but are reoccurring costs of ownership that are due to closing.
How To Pay For These Costs
Now the total sum of the fees about (outside of the VA Funding Fee which can be rolled into the loan amount) is about 2 to 3% of the purchase price. Now there are three common ways of paying these closing costs and prepaids.
- Buyer Pays: If a buyer wishes to obtain the lowest mortgage rate as well as obtain the home for the lowest purchase price, the buyer/veteran would need to pay these costs from their own savings or proceeds from their home sale. This is the case for nearly all other types of loan types and probably the most common route to proceed. This is the best financial route in most cases.
- Seller Closing Cost Credits: In many cases a buyer can ask the seller to give them funds at closing to apply towards these items. Now this all depends on the transaction, as it is not likely for a seller in a hot market with an asking price that is competitive to provide assistance. However it is not uncommon in a slower paced market or in the offer is on a home that has been on the market for awhile.
- Lender Closing Cost Credits: Another great option available to veterans at some lenders; are lender closing cost credits. Just as a veteran can pay discount points to obtain a below market interest rate; a veteran can get money back from the lender by obtaining a slightly higher than market rate. For example, let’s say a 30-year fixed VA mortgage loan with no discount points is 3.50%. The veteran may have the option to take a 3.875% 30 year fixed rate and receive several thousand dollars from the lender to put towards their closing costs. The payment difference is typically very minor which allows the veteran to only slightly increase their mortgage payment while substantially lowering their out of pocket cuts. In many cases reducing the out of pocket costs to less than $1,000.