No-closing-cost VA loans

By Don Taylor, Ph.D., CFA .

Dear Dr. Don,
We are in the process of buying a new home and we got the Department of Veterans Affairs (VA) loan with 100 percent financing. During the loan process we learned that we would have closing costs, but I thought that because it was a VA loan we would have no closing costs. We see a lot of signs that read $1 VA loans, and $1 down moves you in. What exactly does this mean, since there is a long way from $1 to $8,000?

I thank you in advance for you attention to this letter, and I hope you can help us out understanding this process. We are first-time home buyers and are a bit confused.
Henriette Homeowner

Dear Henriette,
No-closing-cost loans doesn't mean that there aren't closing costs, just that the costs have been shifted in some manner. Often that means that the closing costs have been financed along with the purchase price of the house.

That's not true with VA loans because the VA loan program prohibits closing costs from being added into the loan amount, although the required VA funding fee can be added to the loan amount.

The customary VA funding fee is 2 percent and must be paid to the VA by all but certain exempt veterans. With a down payment of 5 percent or more the fee is reduced to 1.5 percent and a 10 percent down payment reduces the fee to 1.25 percent.

One way that lenders can offer a no-closing-cost VA mortgage is to cover these expenses by charging you a higher interest rate on the no-cost loan. Your real estate agent can also structure a purchase offer so the seller pays closing costs that would ordinarily be paid by you. The seller won't be as flexible in negotiating the purchase price, but as long as the VA appraisal comes in at or above the purchase price, you will be able to finance the full purchase price of your new home.

There really is no such thing as a free lunch. Closing costs are a real expense in securing a loan and have to be paid by someone. The fact that you don't have to come up with the money at closing means that they are paid in some other fashion. If you can't afford to pay these expenses at closing, you still need to understand how they are being paid because odds are that you're still doing the paying; either in the price you pay for your house or the interest rate you pay on your mortgage.


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