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U.S. military veterans have options when it comes to building the home of their dreams. The U.S. Department of Veterans Affairs (VA) backs construction loans, which can be used to purchase land and build a home from scratch. Obtaining a VA construction loan involves multiple steps, such as purchasing land, finding interim construction financing, and converting that loan into a VA-backed mortgage loan. We cover the requirements for a VA-backed construction loan and what you'll need to do to secure financing.
Can You Use a VA Home Loan to Buy Land?
Yes, you can use a VA home loan to buy land—but only if you can show that you intend to build a home on that land. The Department of Veterans Affairs finances land purchases by eligible veterans who submit a definite construction plan and schedule prior to funding. Purchasing land with VA financing is best suited for people interested in building and living in their own home.
The process for obtaining a VA construction loan can also involve multiple lenders. Because lenders aren't able to issue VA land loans on their own, you must initially fund your land purchase and construction costs with a non-VA land loan that typically covers the first six to 18 months of work. Once the property is finished, you can then convert the loan into a permanent VA loan with your current lender or refinance it into a VA loan with another lender.
How Do You Get a VA Construction Loan?
You can get a VA construction loan by obtaining interim financing with either a private land loan, construction loan or both. Once construction is finished, you can convert your interim debt into a VA loan or refinance into a VA loan. True VA construction loans are very rare. The major draw for most VA borrowers is the ability finance 100% of their property acquisition costs.
Few if any lenders are willing to take on the risk of 100% financing on construction loans. Due to the additional risk associated with new construction and the complexities of dealing with the VA, you’ll be hard pressed to find a construction lender willing to provide VA financing from the very start.
As a result, anyone looking to finance new home construction with VA backing will need to start with a non-VA land or construction loan. Construction lenders will usually require a down payment of no less than 20%. The financing will cover the initial purchase of the land, planning and the construction of the structure over the estimated timeline.
While a bit of a roundabout approach to obtaining financing, using short-term construction financing doesn't preclude you from getting a VA loan over the long term. Some construction lenders let you convert your construction loan into a permanent VA loan once the property is complete. However, if they don't, you can always choose to refinance your construction loan to a permanent VA loan with another lender. At this point, the process will be similar to a standard VA loan application, which involves appraising your new home and approving the underwriting.
VA Appraisal Process
An approved VA appraiser must evaluate the property and assign it a value. Once the construction is complete, an appraisal will establish the market value of the property. This ultimately determines your maximum loan amount. You must also meet specific property requirements regarding safety, habitability and longevity, as defined by the VA. The minimum property requirements are listed below.
- Home must meet all state, county and local building codes.
- Property is either a single family, primary residence or approved multi-unit property.
- Property contains safe and adequate heating systems based on the size of the home.
- Property is publicly accessible from the street.
- Property features safe and adequate electricity and lighting based on the size of the home.
- Home has access to both drinkable water and hot water.
- Home provides for the safe and adequate disposal of sewage.
The complete list of minimum property requirements is very broad and covers a wide range of specific property details. Licensed VA appraisers are trained to look for these and confirm them in their reports.
VA Underwriting Approval
A VA-approved underwriter must review your income, assets, credit information and property appraisal to approve your VA loan. The underwriting requirements to convert a construction loan to a permanent VA loan are the same as for refinancing a VA loan and include the following.
|VA Underwriting Requirements|
|Debt-to-income ratio||Your debt-to-income ratio (DTI) should be around 41%–43% or less.|
|Residual income||Your residual income must meet the requirements for your area, which takes into account household size.|
|Credit scores||Your credit scores will need to be 620 or above, with some lenders requiring a minimum of 640.|
|VA eligibility||You will need your certificate of eligibility (COE) as well as your form DD-214.|
While the VA loan program does not set maximum loan limits, its guarantee is currently capped at $484,350 for most areas (certain high-cost areas allow for larger limits). Lenders are able to make loans in excess of these limits at their own discretion, or they can allow borrowers to contribute down payments for the difference where their loan amount exceeds the local limit.
Depending on how much equity you hold in the property, you will need to pay a funding fee to the VA, expressed as a percentage of the loan amount (unless you are exempt). It's worth noting that this fee is higher if you've used your VA entitlement in the past.
Should You Get a VA Purchase Loan or VA Cash-Out Refinance?
You'll generally have two options when it comes to choosing VA financing for your new home construction. The average rate on a VA home loan will vary according to your state of residence.
- VA purchase loan allows you to convert short-term financing into a VA mortgage
- VA cash-out loan allows you to refinance your existing construction loan and withdraw cash.
Choosing between a VA purchase loan and a VA cash-out loan may depend on where you choose to finance the purchase of the land and the construction process. If your lender offers the option, the conversion of a construction loan into a permanent VA loan is effectively considered a new home purchase. The short-term construction financing (not through the VA) is converted into a permanent VA mortgage. If you need to finance as much of the costs as possible and are willing to meet VA requirements throughout the construction process, a VA construction-to-permanent purchase loan would be your best bet.
Alternatively, if you refinance your construction loan with a VA cash-out loan once the property is complete, you can cash out your equity to pay off the construction lender and refinance it into a new VA loan, which converts it to a refinance. Refinancing your new home under the VA's cash-out guidelines allows you to avoid dealing with VA oversight during construction and still finance up to 100% of the home's value. This would be the best option if you have the funds available for a substantial down payment prior to breaking ground. Once construction is complete, you should be able to withdraw your embedded equity through a VA cash-out refinancing.
VA Purchase Loan vs. VA Cash-Out Loan
|VA purchase loan|
|VA cash-out refinance|
Alternative Financing to VA Construction Loans
It may be difficult to obtain a VA loan in some markets. While VA loans feature attractive benefits, oftentimes borrowers may find it easier to go with an alternative when restrictive underwriting standards get in the way.
Standard construction loans
These allow you to finance your land and construction together, then convert the loans into a standard mortgage once construction is complete. One of the downsides of this approach is that it usually requires a sizable down payment of 20% or more, and you must meet the construction lender's underwriting requirements.
Home equity loan or HELOC
If you own significant equity in another property, you could draw on its equity to finance the costs of your new home construction. Once the new construction is complete, you can take out a mortgage against your new property and pay back your home equity loan with the proceeds. The obvious drawback of this approach is that it puts your other home at risk should your construction costs exceed estimates.
USDA Rural Development Construction Loan
For properties located in rural areas (as determined by the U.S. Department of Agriculture), eligible borrowers can obtain construction loans with similar terms to VA loans. This includes up to 100% financing, provided the borrower uses an approved builder and follows all lending criteria. These loans are only available for construction in USDA-designated rural areas, and borrowers will need to meet a separate set of underwriting requirements.