Using a VA Loan in a Competitive Market

Posted by Luke Korkowski on Jul 31, 2018 in News

If you want to buy a home in Kaneohe or Kailua with a VA loan, you’re probably going to be competing against several other buyers.

You may also have heard that sellers are a bit skittish about VA offers which, generally speaking, is true. Let me explain why, and then I’ll discuss possible actions you can take to make your VA offer more appealing to sellers.

The policy behind the VA loan is that the Veteran’s Administration wants qualified veterans or active duty military to be able to purchase a home without putting money down. Note that the VA doesn’t lend money; it guarantees to the bank lender that the loan will be paid. So you’re still dealing with a private bank for obtaining your loan.

Currently on Oahu a veteran can purchase a home valued at up to $721,050 without paying any cash towards the purchase. Keep in mind the buyer would still have to pay for home inspections and some other ancillary items, but the down payment is $0.

For veterans wanting to buy a property over the $721,050 limit, they still get quite the deal. They just have to put down 25% of the difference between the purchase price and $721,050. The maximum VA loan amount (not purchase price) is $1.5 million.

This is a wonderful benefit for those who qualify.

However, the VA has some requirements that it imposes on the buyer, on the property being purchased, and on the other parties involved. There are also some practical market realities that affect the VA buyer’s competitiveness when compared to buyers using a conventional loan.

For starters, the buyer has to be eligible for the VA loan. To find out whether you’re eligible, talk to a loan officer like Stefan Kant or Brenda Carr. This is pretty easy and rarely presents a problem after the initial screening by the loan officer.

In addition, though, the property condition has to be up scratch. There is a whole slew of guidelines on this (like these), but the gist of it is that the property has to be reasonably ready for a veteran to move into, with the assumption that the veteran has no cash to make improvements.

In broad practical terms, that means the property cannot have broken windows, significant termite damage, torn-up flooring, unpermitted electrical or plumbing work, or any other features you might associate with a fixer-upper. If a property’s condition is iffy, the parties may find themselves in a situation where the seller has to fix certain items in order for the deal to close because the buyer — generally speaking — isn’t allowed to fix them even if the buyer is capable of doing so.

Further, there is a general consensus among real estate agents on Oahu that VA loan appraisers come in with lower values than they should. An appraiser is a neutral third party — paid by the buyer but hired through a randomized process — who looks at the home and tells the bank what the home is worth. The bank will then base its lending decision on the appraiser’s value.

Here’s the problem: Appraisers generally can only use similar properties that have already sold as the basis for determining the value of the home the VA buyer has under contract. In a competitive seller’s market, buyers are actively driving up the price of homes. That means that appraisers will typically undervalue homes in a rising market because they can see what values were, but not what they are.

Non-VA buyers who are using financing have to deal with this problem, too, but it tends to be the case — or, at least, agents on Oahu tend to believe — that non-VA appraisers aren’t valuing properties as low as VA appraisers are.

Some additional considerations come into play, too. Since VA buyers usually don’t put any (or much) money down on their home purchases, many seller’s agents assume that VA buyers don’t have cash. Sellers and their agents like buyers who have cash available. That way if anything unexpected pops up during the escrow period — the 45-60 days from the mutual signing of the contract until money and keys change hands — the buyer would have the means to address it.

One item that could pop up is, you guessed it, a low appraisal. Say you’re a VA buyer under contract for a small Kaneohe home for $720,000. Imagine the appraiser issues his report saying that the home is really worth $715,000. If that’s the case, the bank will only lend you $715,000 to buy the property.

At this point, a VA buyer has three choices: cancel the contract, pay the $5000 difference cash, or renegotiate the price. In a competitive market, usually the seller won’t want to renegotiate, so either the buyer cancels the contract or coughs up the dough.

The same is true for a buyer using conventional financing, with the exception that a conventional buyer at least has the option to include an “appraisal clause” in the purchase contract which would waive the buyer’s right to cancel based on a low appraisal. A VA buyer does not have that option. Appraisal clauses aren’t great for buyers, typically . . . unless they are trying to make their offer as appealing as possible in a competitive market like we have in Kaneohe and Kailua.

So seller’s agents know ahead of time that the VA buyer’s lack of cash to complete the deal is a problem that needs to be solved, and because of the policy behind VA loans — where veterans need no cash in order to buy a house — seller’s agents assume, rightly or wrongly, that VA buyers do not have any cash reserves.

Let’s pause to sum things up.

  1. The property has to meet the VA’s minimum property requirements. If it doesn’t, either the deal fails or the seller has to do repairs.
  2. VA appraisals tend to come in low — or at least that’s what Oahu agents tend to believe — and VA buyers have an escape clause allowing them to cancel the contract if the appraisal is low.
  3. Agents assume that VA buyers do not have cash to address contingencies, like a low appraisal.

So how do we solve these problems upfront and make VA buyers look competitive against conventional buyers? The first thing is to screen the property ahead of time. An experienced buyer’s agent should be able to look at a home and know with a reasonable probability whether the property meets the VA’s minimum property requirements.

Avoid the fixer-upper with a VA loan.

If the home looks iffy, the agent should be able to articulate that to the buyer. And in such cases, the seller’s agent almost certainly has similar misgivings about the prospects of the property meeting the VA’s requirements. A buyer can try to offer to fix things that need fixing, but the buyer’s lender might get squeamish about such promises as they skirt the edge of what’s really possible with a VA loan.

Informally waive the appraisal escape clause.

With respect to appraisals, even though a VA buyer cannot waive the escape clause, the buyer can make a moral promise to make up the difference between the contract price and the appraisal value. That moral promise is likely unenforceable, but it is sometimes enough to persuade sellers to select the VA buyer’s offer.

Note two things here: (1) You’ve got to mean to make good on your moral promise, and (2) you should set a cap on your cash obligation so that you don’t end up paying way more out of pocket than you meant to.

For example, say you’re putting a VA offer on the $720,000 Kaneohe house we were talking about earlier. You can write a cover letter that says you promise to make up the difference in cash between the contract price and the appraisal value, up to $7000. Then when the appraisal comes in at $715,000, you put in $5000 in cash to make up the difference. But if the appraisal comes in at $680,000, you’re not morally on the hook for making up the difference with $40,000 in cash because that would be way more than the $7000 you committed to.

Prove your funds.

To address the perception that VA buyers don’t have cash to complete a deal, you can package your moral promise described above with a document proving that you have enough funds. This can be a bank statement, an investment account statement, or something similar.

Remind them of what a VA loan means.

Finally, you can emphasize to the seller that the VA loan is designed in part to reward our veterans for the service they have provided to our country. Using that reward against them is unseemly and inconsistent with the gratitude we should all show towards those who have done so much for the rest of us.

The nitty-gritty of purchasing real estate on the windward side of Oahu with a VA loan can be a bit complex, kinda messy, and disorienting. However, with a solid understanding of the details and with some expert guidance, for appropriate properties a VA buyer can effectively compete with conventional buyers.