Buying a home in California can be a challenge. The biggest hurdle preventing most potential homebuyers is the down payment. While there are loan programs, like FHA, that allow for down payments as little as 3.5% down, it can still take time to save that much money. Someone buying a home for $450,000 in California with 3.5% down would need $15,750 for the down payment. And that amount doesn’t include closing costs, prepaid expenses, etc, that could easily add up to another $10,000, bringing the total amount needed to close to over $25,000. But for California Veterans, there is a much better option. A program that doesn’t require any down payment. The VA loan program.
The VA Loan Program allows 100% Financing up to your County Loan Limit
The VA loan program has been around, in some form, since 1944. It was conceived as a way to help returning military Veterans purchase a home. (or farm, etc). Rather than give a cash bonus, VA would guaranty a percentage of the loan, making it a safe program for lenders to offer. In its current form, the VA guarantees 25% of the loan amount, for loans up to a specified county limit. That VA California county loan limit is determined once a year by the Federal Housing Finance Agency, or FHFA. The base limit for most counties in the country and throughout California in 2018 is $453,100. But there are higher cost counties in California, like Los Angeles County, Orange County, Contra Costa County, and many other, with limits as high as $679,650. In those high-cost counties, California Veterans can purchase a home for $679,650 with $0 down payment. For today I am going to give you an example of what a $450,000 purchase using VA financing will look like.
What Do the Numbers Look Like for a $450,000 Home Purchase with $0 Down Payment?
First, we do need to make a few assumptions. We are going to assume this is a single family detached home with no homeowners association dues. We are going to assume a property tax rate of 1.25%, which is fairly typical in California. There are some areas where tax rates are between 1% and 1.05%, and some areas where the property tax rate is nearly 2%. But most are close to 1.25%. I am also going to estimate the homeowner’s insurance using a factor at .25% of the loan amount divided by 12. The homeowner will need to shop for their own insurance, but .25% will work as a solid estimate. I am also going to assume this is the California Veterans first time using VA financing, resulting in a VA Funding Fee of 2.15%. For members of the Reserves or National Guard, the VA Funding Fee would be 2.4% for being first-time users of VA financing. A Veteran with a service-connected disability rating will not have a VA Funding Fee. And lastly, I am going to assume a FICO score of 720+. The example will break down the total payment, including principal, interest, property taxes, and insurance. I will also estimate the required income to qualify for this purchase price. I will also give an estimate of the typical closing costs and prepaid expenses, and give strategies for potentially having the closing costs and prepaid expenses covered using a lender or seller credit.
There is No Down payment required, so the VA loan will equal the purchase price. There is a VA Funding Fee equal to 2.15%, or $9,675 in this case, that is financed into the loan. This makes the total VA loan $459,675.
Interest rates vary from one day to the next, but as of February 12, 2018, and assuming a FICO score above 720, we’ll use 4.25% at 0 points (APR 4.521%). That results in a Principal & Interest (PI) payment of $2,261. Property taxes and homeowners insurance are also part of the payment. They are the “TI” in PITI. The total “PITI” monthly payment is $2,824.
What Income is Needed to Qualify for a $2,824 mortgage payment?
The Debt to Income ratio is the ratio or percentage that compares a borrower’s gross income compared to their monthly payments. The guideline Debt to Income ratio is 41% on VA loans. But realistically VA does not have a maximum Debt to Income ratio. It is not unusual for the DTI on a VA loan to be 50% or higher. If we assume that 50% of the California Veterans gross monthly income can go towards their total payments. And if we assume the Veteran has a car payment of $500 and a minimum credit card payment of $50, then the estimated income needed to qualify for a mortgage payment of $2,824 and other payments of $550 (total of $3,374) would be approximately $6,774. ($3,374/.50% = $6,674).
Closing Cost Breakdown
There are closing costs and Prepaid expenses on all real estate and loan transactions. Even on a VA loan. There are ways to have some or all of those costs paid for (by the seller) or credited by the lender, but one way or another the costs to close do need to be accounted for. Understanding this before getting an accepted offer is very important. Typical closing costs include lender fees, appraisal, credit report, escrow and title fees, and recording fees. In our example, I have estimated those fees to total $6,000. Some of these fees will adjust based on the loan amount or purchase price of the home. The choice of escrow and title companies are negotiated through the purchase contract, but in most cases in the current real estate market, the seller or their real estate agent will have the upper hand in choosing those companies.Also, for this loan example, I have chosen an interest rate at 0 points, meaning there are no Discount points associated with the interest rate. You do have the option of “buying” the interest rate down by paying Discount Points. One Point is equal to 1% of the loan amount. If the loan amount is $459,675, then 1 Discount Point would be $4,597, which would be added to the closing costs. One Point may lower the rate by .25%, which would lower the PI by $66 per month on a $450,000 Base VA loan amount. That may or may not make sense, depending on several factors that should be discussed with your California VA loan officer. On the flipside, it is also possible to go higher in rate. By doing this you would receive a lender credit that could be used to cover closing costs and/or prepaid expenses.
Prepaid expenses include mortgage interest, property taxes, and homeowners insurance.
- Prepaid mortgage interest occurs when a loan closes at some time in the middle of the month. For example, if a VA loan closes on June 15 then there would be 15 days of “prepaid interest” due at closing. The time period covering June 16-June 30 is the 15 days. Your first mortgage payment would not be due until August 1, or 45 days after the closing, which is awesome. If the loan were to close on June 29, then there would only be 5 days of Prepaid interest. But the first payment would still be August 1, or only 31 days after the closing. Either way, the homebuyer is just paying for the interest covering the time period they are in the home that is not going to be covered by the first payment. In our example, we are estimating 15 days of Prepaid interest at $61 per day, or $910.
- Property taxes are paid and/or prepaid/deposited to an escrow/impound account through the closing of the loan. Property taxes and homeowners insurance will be paid through each month along with your Principal and Interest. An Impound account is set up at the closing to make sure there will be enough funds to pay those bills when they come due. The number of months of property taxes deposited into the impound account is dependent on the month the loan closes. Loans that close in April will require 4 months of property taxes to be collected and deposited into the impound account. There may also be “prorated” taxes due to the seller based on property taxes they have already paid that will cover a time period the new buyer will be occupying the home. In the example, we are estimating 6 months of property taxes for the impound account, which is a good conservative estimate. This comes to $2,913. ($468.75 x 6).
- Homeowners Insurance is also prepaid. At closing a 1-year premium is paid. Also, 3 months of insurance are deposited to the impound account. By depositing three months of insurance into the impound account, the lender is making sure there will be enough funds available for renewal 12 months after the closing. In our example, we estimate the 1-year premium and 3 months insurance to be $1,406.
The Impound Account is essentially a savings account for the VA buyer that is held by the VA lender. Your monthly mortgage statement will give you a breakdown of the balance, deposits, and disbursements in your impound account. It is important to keep on top of your impound account. It is also important to be aware that in many cases the lender will not pay the Supplemental tax bill when it comes due. The homeowner should be aware of the Supplemental tax bill in the first year after their home purchase.
In our example, the estimated Prepaid expenses are $5,129. The Closing Costs are $6,000. This means the total amount needed to close is $11,033. As mentioned earlier, the Veteran can negotiate to have the seller pay some or all of the closing costs and prepaid expenses. Another option is to choose a higher interest rate and then use “Yield Spread Premium” to help cover costs. For example, if you went with an interest rate of 4.75% (APR 4.874) you could get a YSP of 1.75%, or in this case, $8,044. ($459,675 * 1.75% = $8,044). This is enough to cover all of the closing costs and even $2,000 of the Prepaid expenses.
The important thing is to understand the numbers BEFORE you make an offer on a home. Make sure the total PITI payment will fit your budget. Make sure you have a way of covering the closing costs and prepaid expenses. Know ahead of time whether you will need to negotiate with the seller to pay costs because you’re not going to be able to negotiate after the offer is accepted and you’re in escrow.
Get PreApproved for a VA Loan Before you make an Offer on a Home
This all seems like a lot. But working with the right real estate professionals can help to make the process easy. You will want to get PreApproved for a VA loan before you make an offer on a home. At the very start of the PreApproval process, you will have a phone or in-person consultation with a California VA Loan Specialist. The VA Loan Officer will then be able to prepare custom loan scenarios based on your qualifications, taking into consideration your payment comfort level, credit, income, etc. Your California VA Loan Officer will also prepare a custom video of your loan scenarios, explaining the numbers and answering questions you may have. Going through this process will give you confidence when you begin making offers on homes.
Authored by Tim Storm, a California VA Loan Officer specializing in VA Loans. MLO 223456. – Please contact my office at the Home Point Financial. My direct line is 949-640-3102. I will prepare custom VA loan scenarios which will be matched up to your financial goals, both long and short-term. I also prepare a Video Explanation of your scenarios so that you are able to fully understand the numbers BEFORE you have started the loan process.