How Do VA Construction Loans Work? A Comprehensive Guide

VA construction loans are a great option for veterans and service members looking to build their dream home But how exactly do these loans work? In this comprehensive guide, we’ll walk through everything you need to know about VA construction loans, including eligibility requirements, the loan process, costs and fees, and more

What is a VA Construction Loan?

A VA construction loan is a mortgage specifically designed to finance the construction of a new home for eligible veterans and service members. It provides financing for purchasing land and building a home on that land.

Unlike a traditional VA loan that finances a home purchase, a VA construction loan is broken up into several disbursements. The lender distributes loan funds in phases as construction is completed. This helps minimize costs and risks for both the borrower and lender.

Once construction is finished, the construction loan converts into a permanent VA mortgage This is typically done through either a VA refinance or a VA cash-out refinance

VA Construction Loan Eligibility

To qualify for a VA construction loan, you must first meet the basic VA home loan eligibility criteria:

• Currently on active duty
• Veteran who served at least 90 days of active duty and was discharged under honorable conditions
• Surviving spouse of a service member or veteran who died in the line of duty or from a service-related injury or disability

You’ll also need to meet additional requirements set by the lender such as

• Minimum credit score – Usually around 620
• Low debt-to-income ratio – Below 45% is ideal
• Sufficient income to repay the loan
• VA certificate of eligibility

It’s also important to use a VA-approved builder and have the home plans approved by the VA lender. The home must be built to VA property standards and requirements.

The VA Construction Loan Process

Getting a VA construction loan involves a few more steps compared to a typical mortgage. Here is an overview of the process:

1. Get Pre-Approved

Work with a VA-approved lender to get pre-approved. This helps you determine your budget and loan amount before you buy land or start building.

2. Find Land and Home Plans

Search for a lot in the location you want. Have a builder draw up construction plans that align with your budget and VA requirements.

3. Submit Home Plans for VA Approval

Your lender will work with the VA to review and approve the building plans. This initial VA inspection determines your maximum loan amount.

4. Close on the Construction Loan

After your plans are approved, you’ll close on the construction loan. This establishes the loan terms like budget, draw schedule, fees, and repayment terms.

5. Start Construction

Once closed, the contractor can break ground and start building! The lender distributes draws periodically as phases are completed.

6. Full Inspections and Home Completion

When construction nears completion, the home must pass final VA inspections. Any issues found need to be resolved before full loan disbursement.

7. Convert to Permanent VA Loan

After the home is finished, inspected, and approved, the construction loan converts into a permanent VA mortgage. This is commonly done through a VA refinance or VA cash-out refinance.

VA Construction Loan Draws

A key difference with VA construction loans is that the loan funds are dispersed over time in multiple installments called “draws.” Here’s how it works:

• The lender sets up a construction loan escrow account where the loan funds are held.
• As certain stages of construction are completed, the builder submits a draw request to the lender.
• After inspecting the completed work, the lender releases funds from escrow to pay the builder.
• This continues over the course of construction until the full loan amount has been drawn.
• The number of draws and amount per draw depends on the lender and length of construction.
• Draws help minimize cost and risk for both parties during the building process.

VA Construction Loan Rates and Terms

VA construction loans typically come with very competitive interest rates since they are backed by the VA. Here are some key points on rates and repayment terms:

• Fixed rates – Most lenders offer fixed rates which don’t change over the loan term.
• Rate term – Expect rate terms between 15-30 years for the permanent VA loan.
• Construction phase – You usually don’t make payments during construction which typically lasts 6-12 months.
• Loan fees – Can include the VA funding fee (up to 2.3%) along with lender origination fees.
• Closing costs – Expect to budget 1-5% of the loan amount for various closing fees.

Always shop around with multiple lenders to find the best combination of low rates, reasonable fees, and good service.

VA Construction Loan Costs and Fees

When budgeting for a VA construction loan, be prepared for the following common fees and costs:

• VA funding fee – Up to 2.3% of the loan amount. Reduced with a down payment.
• Closing costs – Average 1-5% for origination, appraisal, credit check, recording fees, etc.
• Construction fees – Some lenders charge 1-2% of the loan for construction monitoring.
• Draw fees – $50+ per draw is common to process each installment.
• Lot purchase – Budget for purchasing land if you don’t already own a lot.
• Construction – The bulk of costs go to the builder for labor and materials.
• Contingency fund – Have 10-20% extra for unexpected overages during building.

While closing fees can add up, you may be able to finance these into the loan amount. Shop around to find lenders with the best rates and lowest fees.

VA Construction Loan Requirements

When applying for a VA construction loan, there are a variety of requirements and documents you’ll need to provide:

• VA Certificate of Eligibility – Verifies your VA home loan eligibility status.
• Credit history – Minimum 620 FICO score is common. Need good credit.
• Income verification – Pay stubs, tax returns, bank statements to confirm income.
• Debt-to-income ratio – Ideally below 45% DTI for approval.
• Construction plans – Must be approved by VA appraiser and lender.
• Builder approval – Licensed, bonded, insured builder must be VA-approved.
• ** permits** – Obtain necessary permits for construction.
• Inspections – Mandatory inspections at big milestones during the build.

Pro tip: Work with a reputable lender that specializes in VA loans. They can help guide you through the entire process.

Choosing a VA Construction Loan Lender

Not all mortgage lenders offer VA construction loans, so finding the right lender is key. Here are some tips for choosing a quality lender:

• Find a lender that specializes in VA loans and is very familiar with VA construction financing.
• Look for an efficient lender that can handle the extra paperwork and draw process smoothly.
• Ask about their builder network. Established relationships help streamline coordination.
• Seek out positive reviews from other veteran borrowers on their construction loan experience.
• Compare interest rates, fees, and closing costs from multiple lenders.
• Opt for an online lender with fast processing and easy document uploading.
• Pick a lender that provides outstanding customer service and communication.

Taking the time to find the right lender for your unique situation can save you money and headaches during the building process.

Alternative Construction Loan Options

If you don’t qualify for a VA loan, there are alternative construction loan programs you may consider:

FHA construction loans – Offer low down payments and flexible credit requirements like VA loans.

USDA construction loans – For building in rural areas. Offer guaranteed low fixed rates.

Conventional construction loans – Typically require 10-20% down and have stricter credit score requirements.

Portfolio construction loans – Offered by community banks and credit unions. May offer more flexibility than conventional loans.

Be sure to talk to a few different lenders to weigh all your construction financing options. While VA loans are very competitive, you may find another loan better suits your needs.

The Bottom Line

VA construction loans provide veterans, active duty service members, and surviving spouses a viable way to build a brand new home with their VA home loan benefit. They offer competitive rates without requiring a down payment in most cases. Just be prepared for a more lengthy process compared to a typical mortgage. Do your homework to find a solid VA-approved lender who can help guide you through every step from breaking ground to handing over the keys at closing. With the right preparation and partnerships, you’ll be well on your way to building your dream home.