Due to the VA loan program’s zero-down, low-interest terms, veterans frequently ask for tips on using a VA loan to invest in real estate. In this article, we’ll cover the considerations and strategies available for veterans who want to invest in real estate with the VA loan.
Specifically, we’ll cover the following investing-related topics:
- VA Home Loan Overview and Advantages
- Limitations on Real Estate Investing with the VA Home Loan
- VA Home Loan Investment Strategy 1: “House Hacking”
- VA Home Loan Investment Strategy 2: Modified Flipping
- VA Home Loan Investment Strategy 3: Doubling Up
- Additional Considerations
- Final Thoughts
VA Home Loan Overview and Advantages
The VA home loan has its roots in the 1944 Servicemen’s Readjustment Act. This bill, in addition to creating educational and job-training opportunities, provided veterans returning from World War II an affordable path to homeownership.
Administered by the Department of Veterans Affairs and somewhat different than its original form, today’s VA home loan program is an extremely attractive option for real estate investors due to the following characteristics:
- No down payment required
- No private mortgage insurance (PMI) required
- Low interest rates (due to partial government guarantee of the loan*)
*The VA does not actually originate and service loans. Banks and other mortgage lenders do, and the Department of Veterans Affairs guarantees a portion of the loans, thus minimizing risk for the lenders.
Typically, the largest obstacle faced by new investors is coming up with enough cash for a down payment on a rental property. As such, veterans look at the above advantages and – quite understandably – ask how they can use the VA loan to begin investing in real estate.
Limitations on Real Estate Investing with the VA Home Loan
What’s not to like? No down payment. Low interest rates. No PMI. Why wouldn’t veterans use the VA home loan to invest in real estate? Well, before investing, veterans need to first understand the limitations imposed by the Department of Veterans Affairs, as this loan product is meant to support homeownership, not investing.
- Occupancy requirements: The first thing veterans need to understand about using the VA loan to invest in real estate involves occupancy. As the VA wants to promote homeownership, it mandates that veterans actually live in the VA loan-purchased home for a certain amount of time. Though the specifics can be adjusted on a case-by-case basis, this typically means that borrowers need to move into a home within 60 days of loan closing and live there for at least a year.
- “Safe, sound, sanitary” appraisal: Once again, as the VA wants to promote homeownership with its loan program, it imposes more stringent appraisal standards than most other loan products. This means that homes purchased with a VA loan need to be actually habitable, that is, not in need of significant maintenance or improvement (hence “safe, sound, sanitary”). As such, investors pursuing a typical fix-and-flip approach will likely not qualify, as these sorts of homes tend to need too many repairs to meet the VA’s standards.
- Using future rental income as qualifying income: While each VA lender has different requirements, most will not consider future rental income in determining your debt-to-income (DTI) ratio for loan qualification unless you A) have at least a two-year track record, as proven by tax returns, as a landlord; or B) use a property management company. And, leases need to be actually signed prior to any consideration of future rental income.
Now that you understand its inherent limitations, we can discuss three available strategies for real estate investing with the VA loan.
VA Home Loan Investment Strategy 1: “House Hacking”
If you’ve listened to real estate podcasts or scrolled through blogs, you’ve likely heard the term “house hacking” thrown around as a real estate investing strategy.
Put simply, house hacking means having tenants fully or partially pay your mortgage while you live in the house, too. In other words, let roommates or tenants in another unit pay the bills with their rent payments while you live at home for free.
So how does this work with a VA loan? Well, investors have two options, depending on their unique circumstances.
- Option 1 – single-family home with roommates: Okay, this option probably only makes sense for young and single veterans, but it is an option. Say you only personally need a two-bedroom home. Instead, you purchase a three- or four-bedroom house with your VA loan. Then, you move into the one or two bedrooms you need, rent out the other two, and share the common spaces with your roommates. In a basic example, if you have a $1,000/month mortgage and rent each extra bedroom for $500/month, you live there for free, as tenant rent payments cover your mortgage.
- Option 2 – the “plex” approach: This is a better approach for veterans with families – or who just like their privacy. While not common, the VA actually allows borrowers to use the VA home loan to purchase duplexes, triplexes, or quadplexes, so long as the veteran occupies at least one of the units. While veterans will still need to demonstrate a high enough DTI to qualify for the loan (recognizing the above future rent qualification limitations), this strategy does work. And, as with the single-family home approach, a well-analyzed deal will ensure that your tenants’ rent payments cover your mortgage (and potentially more).
VA Home Loan Investment Strategy 2: Modified Flipping
As discussed above, traditional house flipping involves finding an undervalued property in need of significant repairs, renovating it, and selling it for a profit. However, due to the VA’s “safe, sound, sanitary” appraisal requirements, this strategy won’t work with the VA loan.
But, investors can use a modified flipping strategy. With this approach, veterans look for qualifying homes (the appraisal requirement) that they’re willing to move into for at least a year (the occupancy requirement) but that could have value added with some improvements.
Put simply, just because a home is habitable doesn’t mean that it couldn’t stand to have some improvements. Maybe the kitchen could be modernized, or a deck expanded, or an unfinished basement updated into a second living room – or any other of the countless value-adding improvements homeowners can make.
Having said that, here’s how modified flipping with a VA loan works:
- Step 1: Buy a home slightly under market value (typically due to some needed modernizing for aesthetic, not functional/habitable reasons).
- Step 2: While living in the home for a year to meet the occupancy requirements, conduct value-adding improvements.
- Step 3: After a year and with improvements complete, sell the home for a profit (if properly analyzed, the final sales price will be greater than the sum of the original purchase price, holding costs, and improvements).
And, the best part for VA loan real estate investors? After “flipping” the home at a profit, you just need to file some paperwork with the Department of Veterans Affairs to have your VA loan entitlement reinstated, making this an awesome and replicable investment strategy.
VA Home Loan Investment Strategy 3: Doubling Up
Most veterans don’t realize it, but you can use the VA loan twice, that is, you can have two VA loans outstanding on two properties – at the same time. This reality creates an opportunity for veterans to indirectly buy a rental property with a VA loan. However, to understand this investment strategy, we need to provide some background on VA loan entitlement.
The Department of Veterans Affairs guarantees 25% of VA loans – not 100%. And, the VA currently guarantees up to $127,600 (though this number is A) annually adjusted, and B) larger in some higher cost of living areas). This means that, without needing a down payment, eligible veterans can borrow up to $510,400 ($127,600 entitlement x 4).
But, what if your first home costs less than $510,400? Here’s where this investment strategy begins.
When a veteran uses the VA loan, a portion of his or her entitlement becomes tied up in the mortgage. So, if a veteran purchases a $200,000 home, $50,000 of entitlement is committed ($200,000 x 25%). But, as discussed, total entitlement is $127,600 ($510,400 x 25%). In this scenario:
- Total guaranteed entitlement: $127,600
- Minus 1st loan entitlement: -$50,000
- Equals remaining entitlement: $77,600
In this scenario, $77,600 x 4 = $310,400, which means that this veteran could use the VA loan a second time to purchase a $310,400 home without a down payment, leading to the following real estate investing strategy:
- Step 1: Buy a home with a VA loan for an amount less than your total entitlement.
- Step 2: Live in this home for a year.
- Step 3: Use a second VA loan to purchase a new home, moving into it as your primary residence (your remaining entitlement will dictate how much you can spend without a down payment).
- Step 4: Convert the first home into a rental property.
NOTE: Just because veterans have entitlement remaining does not mean that they will actually qualify for a second VA loan. Borrowers still need to meet the credit, income, and asset requirements necessary to qualify for a loan.
After outlining the above VA loan real estate investing strategies, veterans would be wise to consider the following prior to diving head first into the investment world.
- No-equity dangers: While the VA loan’s no down payment characteristic makes buying a home far easier, it also means that purchasers have zero initial equity in their homes. Consequently, in the case of a market downturn, VA borrowers face the danger of becoming “underwater,” that is, owing more on the loan than the home is worth. In these situations, borrowers typically cannot sell or refinance their homes.
- Need for thorough deal analysis: Just because a home makes sense to buy doesn’t mean it’ll make a good investment property. Before using a VA loan to purchase a home with a plan to turn it into a rental property, investors still need to conduct the requisite cash flow and expense analysis to confirm that market rental comps for a property will cover its associated expenses.
Despite its inherent limitations, several outstanding strategies exist to use the VA loan to invest in real estate. As long as veterans conduct the due diligence required in any investment property deal, using the VA home loan can be a great, zero-down option for entering the real estate investment world.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.
|Using A VA Loan for Real Estate Investment||Flipping a Home with a VA Loan|
|VA Loan for Mixed-Use Property||Using A VA Loan To Buy A Duplex or Multi-Family Unit|
|VA Loan For A Second Home||VA Loan Entitlement|