Credit Standards When Purchasing with a VA Home Loan

“The Three C’s” is a common phrase often heard in the home-buying process. Standing for credit, capacity, and collateral, these rules have stood the test of time when buying or selling a home.

Here’s what they mean:

• Collateral refers to the amount of funds needed to close on a transaction, including a down payment, as well as the nature of the property being financed.

• Capacity refers to the ability of the borrower to comfortably repay the debt.

• Credit is having a history of repaying previous obligations on time as well as the nature of current and past credit accounts.

VA loan buyers will find that this government-backed mortgage program doesn’t require a down payment, and closing costs are limited, so collateral might not be as important compared to other loans. And capacity, though playing an important role with debt-to-income ratios and residual income, is fairly straight forward when calculating and verifying.

Credit, though, can be a bit nebulous at times, which is why I’d like to take a deeper look at how VA loans view credit.

Credit Scores

VA lenders use credit scores derived from an algorithm developed by the FICO Company. Credit scores are three digit numbers ranging from 300 to 850, with the higher scores generally signifying better credit. The VA has never required a specific credit score, but does require lenders to establish that borrowers have demonstrated responsible credit behavior.

There are three main credit repositories: Experian, Equifax, and TransUnion. Each provides their own score to a VA lender when requested, and while the scores will be similar, they may not be exactly the same. If a lender pulls three scores, often the middle score is used and the lowest and highest scores thrown out. Most VA lenders today require a minimum credit score of 620 for a VA loan approval.

Alternate Credit

Sometimes, especially for those brand new to the credit markets, there won’t be three scores. Sometimes there is only one or even none available because the consumer has yet to apply for credit. In such an instance, does the individual need to wait and establish credit? Maybe, but some lenders allow for what is referred to as “alternate credit” sources.

Alternate credit is established with at least 12 months of timely rental payments as well as 12 months of on-time payments to various utility companies such as a mobile phone account, water, or an electricity bill. The individual can provide 12 months of payments showing that no payments have been made more than 30 days past the due dates.

VA Loans and Bankruptcy

After a bankruptcy, lenders may approve a VA loan application as long as there have been at least two years since the discharge. There are two common types of bankruptcy with the most prevalent being a Chapter 7 bankruptcy, which wipes away all dischargeable debt. The other type of bankruptcy is a Chapter 13 and is sometimes referred to as a “wage earners” plan because the delinquent debt is repaid over time, usually a three- to five-year period.

The waiting period for the Chapter 13 can vary depending on what type of debts were included in the bankruptcy and how long payments have been made. It’s possible a lender can approve a new VA loan in as little as 12 months into the Chapter 13 repayment plan, but the loan request must be approved by the trustee overseeing the plan. Other situations, it may be two years after discharge. Consult with a VA Approved Lender for further clarification on your specific situation.

Foreclosure

After a two-year waiting period and reestablished credit, a borrower may qualify for a VA loan after a foreclosure or a short sale in much the same manner as the VA treats a bankruptcy. If the foreclosed loan was secured with a VA Home Loan and the deficiency has not been repaid (which is typical), it can be difficult to qualify for another VA Home Loan. However, it’s not impossible. If the veteran has reestablished credit in at least three trade lines along with timely rent payment, second tier entitlement might be a remedy.

A second tier can be available in such an instance when there is little or no entitlement remaining. Borrowers can finance a purchase above $144,000 using second tier entitlement. There is some math involved but the amount of entitlement in the foreclosure must be subtracted from the maximum guarantee for the area and then multiplied by four for the new amount. Confusing maybe, but speak with a VA loan officer familiar with the process.

VA guidelines are a bit more forgiving regarding credit, and it’s so important to understand that what you may consider bad credit may in fact not be in the eyes of a VA lender. There are other factors involved approving a mortgage loan. Talk to your VA loan officer. If in fact credit isn’t where it should be, your loan officer can help put you on a path to get your credit back in shape.