What is a VA construction loan, and should you use it to build a home?

If you’re an active or veteran member of the military and want to build a new home, you might be eligible for no-down payment financing backed by the U.S. Department of Veterans Affairs. Here’s what you need to know about building a home with a VA construction loan.

What is a VA construction loan?

A VA construction loan is a short-term loan to cover the cost of building a home, similar to other kinds of construction loans. In contrast to regular mortgages, you don’t receive a lump sum with this sort of financing. Instead, you take it through a series of fund “draws” as different stages of the construction process are completed. The money can be used to finance the land or lot purchase as well as the actual building of the home, plus the loan funding fee. However, you can’t finance any other closing costs, such as the appraisal fee.

VA loans generally don’t require down payments, and that applies to these construction loans as well. However, in certain circumstances, you may have to put up some cash (see “How to get a VA construction loan” below).

Types of VA construction loans

There are two common VA construction loan options to choose from:

• Construction-to-permanent or one-time/single close loan:You take out a construction loan to cover the cost of the project; the loan then converts to a “regular” mortgage, and you start making repayments. With this kind of arrangement, you’ll only have to do the paperwork and pay for closing costs once.
• Construction-only or two-time close loan:Your initial loan pays for the construction, and comes due once the project is complete. You then take out a regular mortgage, which you use to repay it. This means you’ll go through two loan closings, and need to qualify for the second loan as you did for the first. But you might get a better deal on this mortgage, especially if interest rates have dropped in the time between construction and completion.

VA construction loan requirements

To qualify for a VA construction loan, there are several requirements you must meet, including working with a VA-approved lender. The other eligibility criteria include:

• Certificate of eligibility (COE)— This comes from the VA. You can file for this certificate online or submit VA Form 26-1880 to your local VA office.
• Credit score – There’s no minimum set by the VA, but most lenders require a credit score of at least 620.
• Debt-to-income (DTI) ratio – You’ll need to have a DTI of 41 percent or less to get most VA loans, although there are circumstances where that requirement is waived (if you have tax-free income, for example).
• Affordability. In addition, using a formula based on your home’s location, the size of your household and other factors, you’ll need to show that you can handle your loan payments with your residual income.
• Funding fee – VA loans don’t charge mortgage insurance for minimal down payments, but they do carry one-time funding fees. These range from 1.25 percent to 3.3 percent, based on the size of your down payment and how many times you’ve used a VA loan.
• Builder approval – In addition to using a VA-approved lender, you’ll also need to use a VA-approved builder. Your builder needs to either already be registered with the VA or get their approval by registering with the department.
• Construction plans – You’ll need to submit your construction plans to the lender, including blueprints and the materials needed for the project, and get an appraisal to determine the value of the home you plan to build. Additionally, you’ll need a VA property certification before you can move forward.
• Warranty – You’ll need at least a one-year warranty from the builder or an insured 10-year protection plan.

If these conditions are met and you’re approved for a construction loan, know that a VA inspector will be paying attention to the project every step of the way. As each major phase of the build comes to an end, the inspector will review the work and then approve further draws to cover costs.

How to get a VA construction loan

Not many mortgage lenders offer VA construction loans, so it might be challenging to find one to fund your project. When you do find one, your loan officer can help you obtain your COE and determine how much loan you qualify for.

Generally, the process works like this:

1. Get your Certificate of Eligibility: Your COE serves as evidence you’re eligible for the VA loan benefit. You can obtain this through your lender, the VA portal or by mail.
2. Work with a VA-registered builder: You can only work with contractors approved by the VA. Your builder can help you organize the construction plans and other documentation for your lender.
3. Find a VA-approved lender: There are several major VA lenders that work with borrowers nationwide, but your bank or credit union might also offer what you need. Shop around.
4. Get preapproved: Your loan officer can help you determine whether you need a one- or two-time close loan. For a preapproval, you’ll need to meet all of the VA and lender’s requirements around credit and finances.
5. Do an appraisal: Your lender will order an appraisal of the soon-to-be-built property (that is, they’ll evaluate the lot and the home design). If the appraisal comes in lower than the project’s cost, you’ll need to make up the difference.
6. Approve the construction draws: As construction progresses, it’s subject to periodic inspections. After passing one, your lender will have you approve a release of funds, which go directly to the builder, for the next stage of the project.
7. Pass the VA inspection: Once the project is complete, you’ll need to have an inspection to ensure it meets VA standards.

VA construction loan pros and cons

Pros of VA construction loans

• Might not need a down payment
• Potential to have the funding fee waived for certain veterans, such as those with service-connected disabilities
• No mortgage insurance
• Can roll closing costs into the loan
• More relaxed credit and income criteria

Cons of VA construction loans

• Builder and lender must be VA-approved
• Some appraisals can take longer
• Interest rates and closing costs can be higher than on conventional mortgages
• Funding fee charge
• Less choice among builders or lenders

Alternatives to a VA construction loan

If you’re having difficulty finding a VA construction loan lender, or if you don’t qualify for a VA construction loan, you have at least two other financing options:

• Traditional construction loan – One option is to get a traditional construction loan during the build and then a VA loan to finance the home.
• Government-backed construction loan – Another option is to get another government-backed construction loan, such as an FHA construction loan or a USDA construction loan if you’re in a rural area.

Keep in mind, however, that these might have different requirements or more rigid underwriting compared to a VA construction loan.

VA construction loan FAQ

• What can I build with a VA construction loan?

  VA construction loans must be used to construct a single-family home. These loans aren’t designed for building multifamily housing or other projects.
  
  
  While you can make some customizations to the home, avoid adding anything too far out of the ordinary to the design. Overall, it’s important to make sure what you build is similar in size and style to other homes in the area. The same is true of the lot size — when you build, try to do so on a lot that is similar in size to others in the area.
  

• What are the differences between VA construction loans and regular construction loans?

  In general, a regular construction loan has more rigorous underwriting requirements, such as stricter credit score and DTI criteria. Additionally, you’ll likely need to make a substantial down payment to get a regular construction loan. With a VA construction loan, you don’t usually need to make a down payment, and you have a little more flexibility with credit requirements. For some veterans, it can be easier to get a VA construction loan than to qualify for a regular construction loan.
  
  
  However, you might be subject to more scrutiny and restrictions with a VA construction loan compared to a regular construction loan. In the case of a VA construction loan, the lot size and type of home you’re allowed to build are usually limited, and the project might take longer to finish depending on the frequency of inspections.
  

• Where can I find a VA construction loan lender?

  Not all VA loan lenders are also VA construction loan lenders. A lender might offer a VA loan for a home purchase, but not a VA loan to build a new home. To find a VA construction loan lender, start by visiting the VA website to get a list of VA-approved lenders.
  
  
  It can be beneficial to work with a lender that has experience with VA construction loans because there are a number of qualifications and steps in the process. Before you commit to a VA construction loan offer, compare rates and terms between lenders, if possible.
  

• What are VA construction loan rates?

  Construction loan rates in general are higher than the rates for a mortgage used to buy an existing home. That’s because a mortgage is a secured loan — meaning the home is the collateral — and if you default on your payments, the mortgage lender can recoup its losses by selling that collateral. Lenders don’t have this option with a construction loan, since the home isn’t built yet, so the lender is assuming more risk and setting rates accordingly.
  
  
  Note that individual lenders set their own interest rates for VA construction loans; the VA doesn’t determine rates. The rates you see advertised by a lender can also change multiple times throughout the day.