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What is a VA construction loan, and how does it work?
Active-duty military members and veterans who are interested in building their dream home rather than buying a house may be interested in taking out a VA construction loan. Similar to construction loans not backed by the U.S. Department of Veterans Affairs, a VA construction loan is a short-term loan product that the borrower can use to finance the construction of a new house.
Read more: How does a construction loan work?
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What is a VA construction loan?
A VA construction loan is a type of home loan insured by the VA and offered to veterans, service members, and their surviving spouses as a thank-you for their military service. Unlike a mortgage, a VA construction loan is a short-term loan that covers the cost of building a new home. Eligible borrowers can use a VA construction loan to build a house on land they already own or purchase the land along with the construction cost.
Learn more: What is a VA home loan, and who is eligible?
How does a VA construction loan work?
You must close on your VA construction loan before construction can begin. This is because the funds from a VA construction loan are typically placed in escrow as of closing. The escrowed money is paid to the builder directly during construction.
Your VA construction loan payments are not due until home construction is completed. During construction, your builder is responsible for paying interest and any interim builder fees, such as an inspection fee and property taxes.
Like a traditional VA mortgage loan, VA construction loans do not require a down payment. However, borrowers who put $0 down for a VA construction loan will have to pay a funding fee of 2.30%, or 3.60% if they’ve already taken out a VA loan before.
Learn more: Who qualifies for a VA funding fee exemption?
Do you need a mortgage after taking a VA construction loan?
A construction loan is a short-term loan, so it doesn't provide you with the long-term financing you would get with a traditional mortgage. To finance the home you have built with the VA construction loan, you will also need a permanent mortgage that pays off your construction loan and that you can pay off over 15 or 30 years.
Some VA construction loans are set up to automatically become mortgages after construction is completed. These are one-time close construction loans, which means you’ll close on both the construction loan and the mortgage loan at the same time, before construction begins. With a single-close construction loan, your mortgage financing is established prior to the construction, and final terms are negotiated and modified after the construction is completed. These are also referred to as single-close construction loans or construction-to-permanent loans.
Other times, you will close on your VA construction loan and mortgage separately. With these two-time close construction loans, you will have a closing for your construction loan, then a second closing for the mortgage loan that will replace your initial loan. Since these loans have two closings, you will establish the mortgage financing terms after finishing construction.
Whether you choose a one-time or two-time close VA construction loan, your mortgage can also be a traditional VA-backed loan.
How do you get a VA construction loan?
If you are interested in a VA construction loan, you will first need to get a Certificate of Eligibility (COE) that proves you are qualified for a VA loan due to your military service.
Once you have the COE, you can begin shopping for a lender that offers VA construction loans. Not all VA-approved lenders offer construction loans, so finding an appropriate lender may take some time. It’s also essential to compare rates and terms among different VA lenders to make sure you find the best option for your needs.
You must work with a licensed and insured builder who is willing to submit the documentation required to get approved by the lender. When you apply for the loan, you and your VA-approved builder must already have the necessary construction plans and specs for the home drawn up.
It’s standard for the builder to pay closing costs and interest on a construction loan. In many cases, the builder will negotiate to incorporate these costs into the agreement with the borrower. So, although you are not paying these costs directly, they are included in your construction loan’s principal balance. You must also pay the VA funding fee for your construction loan.
Read more: The best VA mortgage lenders
Who offers VA construction loans?
VA construction loans are not as common as VA mortgage loans, so finding one can be more difficult. Since the VA does not offer these loans directly, you will need to check with VA-approved lenders, such as banks and credit unions, to find a VA construction loan that is the right fit. If you need help getting started, try using a mortgage broker to help you narrow down your lender and loan options and find the best deal.
VA construction loan FAQs
Do you need an earnest money deposit for a VA construction loan?
Earnest money is a good faith deposit of money to show the seller or builder that you are serious about going forward with the purchase. No VA loans require an earnest money deposit, but some home builders may need one for a VA construction loan to move forward with the project.
Do VA construction loans require a down payment?
No, VA construction loans usually don’t require a down payment.
What credit score do you need for a VA construction loan?
While the VA does not set a minimum credit score requirement, individual VA-approved lenders do. The minimum credit score may vary by lender, but VA construction loan lenders typically want to see borrowers with a credit score of 620 or higher for a VA construction loan.
This article was edited by Laura Grace Tarpley.
