Can You Add Closing Costs to a VA Loan?
Demystify VA loan closing costs. Discover what can be included in your loan and practical methods to manage all upfront homebuying expenses.
VA home loans offer advantages for eligible service members, veterans, and surviving spouses seeking homeownership. These loans, guaranteed by the Department of Veterans Affairs (VA), often feature competitive interest rates and typically do not require a down payment, making them an accessible option for many. While these benefits simplify the path to homeownership, understanding the associated closing costs and how they are handled is important for borrowers. This article explores closing costs within VA loans and strategies for managing them.
Understanding Closing Costs in VA Loans
Closing costs are fees and expenses paid when a real estate loan is finalized. These costs are distinct from the down payment and typically range from 2% to 5% of the loan amount, though this can vary based on the home’s value, location, and specific loan terms. Common closing costs include appraisal fees, title insurance, recording fees, and lender fees. Appraisal fees cover property valuation, while title insurance protects against title claims. Recording fees register property ownership.
For VA loans, the VA has specific guidelines regarding which fees borrowers are allowed to pay, categorizing them as “allowable” or “non-allowable” fees. Allowable fees generally include the VA funding fee, appraisal fees, credit report fees, recording fees, and title insurance. Non-allowable fees, which the VA prohibits borrowers from paying directly, can include attorney fees, brokerage fees, and certain document preparation fees. These regulations are designed to protect veterans from excessive charges and ensure the affordability of their home loans.
VA Guidelines on Financing Closing Costs
Most standard closing costs generally cannot be directly included in the principal amount of a VA loan. Borrowers typically need to pay these costs out-of-pocket at closing. An exception is the VA Funding Fee. This one-time fee can be financed into the loan amount, increasing the overall loan principal and the total interest paid over the loan’s term.
The VA Funding Fee rates vary based on loan type, first-time or subsequent use of VA loan benefits, and down payment amount. Disabled veterans receiving compensation for service-connected disabilities, Purple Heart recipients, and certain surviving spouses are typically exempt from paying this fee. For eligible veterans with full entitlement, VA loan limits generally do not apply. However, for those with partial entitlement or specific circumstances, limits can apply, varying by location.
Alternative Strategies to Cover Closing Costs
Given that most closing costs cannot be financed into a VA loan, borrowers often explore alternative methods to cover these expenses. One common strategy involves “seller concessions,” where the seller agrees to contribute a portion of the costs. The VA allows sellers to contribute up to 4% of the property’s value towards closing costs and prepaid items, which is more flexible than some other loan types. This 4% limit applies to items like the VA funding fee, prepaid property taxes, or even paying off certain buyer debts, but it does not include standard loan-related closing costs which the seller can also cover.
Another option is utilizing “lender credits,” where the lender may offer a credit towards closing costs in exchange for a slightly higher interest rate on the loan. While this reduces upfront costs, it can result in higher monthly payments and greater total interest paid over the life of the loan. Borrowers can also use gift funds from family members or friends to cover closing costs. These gift funds must be documented with a gift letter stating that no repayment is expected and that the donor is not an interested party in the transaction, such as a builder or real estate agent. There are no VA limits on the amount of gift funds that can be received, though tax implications for the donor may exist.
Other Upfront Costs at Closing
Beyond standard closing costs, borrowers will encounter other upfront expenses at closing often referred to as “prepaid items.” These are distinct from closing costs, which are one-time fees for services, and instead represent payments made in advance for future recurring expenses related to homeownership. Common prepaid items include initial property taxes, homeowners insurance premiums, and per diem mortgage interest.
Lenders typically require a certain number of months of property taxes and homeowners insurance premiums to be paid upfront into an escrow account. This escrow account ensures that funds are available to cover these ongoing obligations, protecting both the homeowner and the lender’s investment. Mortgage interest is also prepaid from the closing date through the end of the month, as mortgage payments are typically made in arrears. While these prepaid items are a necessary cash outlay at closing, they are not fees for the loan transaction itself but rather an advance payment of regular homeownership expenses.