VA Construction Loans: What’s the Catch?
I remember at one point in my career being fairly convinced that VA construction loans were like the sasquatch: there were plenty of references that they existed, but no one I knew had actually seen one in the flesh. The VA lender handbook does describe the ability to use the loan to construct a new home, but lenders who actually offer that are hard to come by. I am one of few lenders in Virginia (certainly the only one I know about) who offers this loan, but I will always shoot my clients straight about the pros and cons.
Pro: You don’t have to put a lot of money down
That’s the main selling point here, truly. All VA construction loans are structured like a purchase transaction, even if you already own the lot, so typically the contract with the builder can be adjusted to reflect a higher cost with credit back to cover your closing costs. As long as the home appraises for sufficient value to cover the loan amount, you can back into financing your closing costs that way.
Con: The closing costs
Your closing costs for any construction loan will be higher than a typical purchase loan. This is mainly because there is more administrative work to be done with a construction loan as the funds are paid to the builder over the course of several installments, or “draws” - each one will require an inspection, update to title, and processing with the lender. Lenders also typically charge an additional underwriting or processing fee to cover their cost with maintaining a department to staff these requests and manage the payments.
Pro: You don’t have to pay during the build
This one even caught me off guard! Unlike a conventional construction loan, where you will pay interest on the amount that has been drawn from the loan during the build period, the VA does not allow the veteran to pay on the home until it is fit for occupancy. This means you make no payments until the home is complete.
Con: Your rate will be higher to reflect that
Because the lender is carrying all the interest cost for the build period as their expense, your rate will be notably higher on a construction loan than a standard VA purchase, since the lender incurs the cost to hold your loan without receiving payment. There’s no real way around that one, and I think that lenders do veterans a real disservice by failing to mention that up front. You typically can float down your interest rate to slightly above market rate upon completion, and then once you have passed the required waiting period and made 6 payments, you will be eligible for a streamline refinance or VA IRRRL. The high rate is not forever!
Pro: You can have exactly what you want
That’s really the goal, isn’t it? My clients who are doing a custom build typically are doing that because they want something that just doesn’t exist elsewhere. I’m happy to go over rough figures with you early on to help you decide if the higher costs versus the standard VA loan are worth it. For the right client, though, the mythical beast does exist, and it is a fantastic option to have available.
