The Big Reason the VA Loan Program is a Trap for New Rental Investors

by | BiggerPockets.com

As many of you know, military members have access to the VA loan program, which allows for owner-occupied purchases to be made with a 0% down payment. This can be a useful way to purchase property with nothing out of pocket. For investors, this sounds like the dream, but that can be very deceiving because it’s not as great as many people would have you think.

You Make Money When You Buy

If this is all you knew about buying real estate, it might be enough. The VA loan requires that you purchase and occupy a retail home—and it’s incredibly hard to make money on a retail home. If you had to, buying a primary with a VA loan in a high appreciation market might not be the worst idea, but anything less is a time sink. You would want to be sure the market you’d be considering would rise, and you would want a strong exit strategy to capture that appreciation. You would also want to spend two years there to avoid capital gains, then run with it. This is the only way I can see a VA loan being a benefit. In almost all other ways for investors, it’s more of a trap than benefit.

As an investor, you want to buy at a discount. Sure, you can make money in the long run if you extend the timeline long enough, but that’s inefficient and disingenuous. The real goal for buying rentals is to buy at a discount, which should be obvious. People see the VA loan as an easy way to get funding, but then they chase the easy way instead of learning the best way—and that’s a mistake.

home-value-factors

Related: How I Built a $1.2M Portfolio While Active Duty With the Help of VA Loans

I’ve Used This Loan Product Myself

When I was young, broke, and didn’t know anything about houses, I had one thought in my head: Buying is better than renting. This was quite the oversimplification, to be sure. I proceeded to go house shopping anyway and found a cheap little condo I could use my VA loan on.

I had $1,100 to my name at the time, and when they asked me for $1,000 earnest money, I made sure to tell them I needed it back at closing. That’s how broke I was! Looking back, I can’t believe they let me buy a house like that. After eight years of owning this house, it’s still my worst performing deal by a long shot, and that’s because I didn’t buy a good deal—I just bought a house I liked and didn’t want to come out of pocket. Don’t make the same mistake as me.

Buying an investment property with 0% down is great, but it’s quite difficult. People see the VA loan and they see 0% and get excited, but the program forces you to buy retail. This is not going to serve your portfolio as well as you hope.

The Devil Is in the Details

There is a funding fee on VA loans.

It’s true that there is no PMI on a VA loan, but there is a funding fee and it’s 2.15% when you bring a 0% down payment. That’s a lot! The savings from having no PMI is reduced thanks to this, further negating much of the benefit here.

You can remove the funding fee completely by being 10% disabled.

This is not a recommendation to get VA disability (who would recommend that?!), but if you are disabled, it’s a small advantage you’ll get. Note: The funding fee will also be removed if you are a surviving spouse.

You can use it for small multiplexes.

This benefit might be a bit more useful, but we still have the main problem: buying a retail property. Buying a 4-plex and living in one corner isn’t the worst idea, but you’re going to have tight cash flow and no equity. Do you really want to hamstring yourself to this one property and build the deal with no wiggle room just to avoid putting anything down?

Another Common Mistake

Two decades ago, when I was PCS (permanent change of station, when the military makes you move), my plan was to buy a house at one duty station. Then, I would put that house up for rent and go buy another one at the new location. Again, this sure sounds good, but is it both reasonable and efficient? I say no.

First, one of the best benefits you get with buying more houses is economy of scale. I have all my properties go through the same process, with the same people, in the same market. This becomes incredibly efficient and saves LOTS of money. Every city you buy in, you’ll need a great ground team, and finding great people is absolutely the single most difficult part of running a good business. Buying in multiple cities destroys any chance for the economy of scale advantage, and it also means you’re never going to know the market really well.

Related: Military Members: Yes, You Can Use Your VA Loan More Than Once. Here’s How.

Imagine 10 locations. Well, now you have to manage 10 property managers, 10 contractors, 10 insurance agents, etc. That’s also 10 deals that won’t have any equity for ~8-10 years, and you want to do all this just to avoid saving for a 20% down payment? Crazy. The capital problem is certainly a hard one to fix, but we all have to find solutions in the long run anyway, so it’s far better to start now rather than buying a retail home. Few things are worse than paying appraised value for an investment.

Focus on Finding Great Deals—Period

The real trap of the VA loan for investors is the tendency to build deal strategy around this loan product rather than build an ideal strategy and then go find the ideal financing to fit. Chasing this 0%-down shiny object creates a mess of the whole process because it gets people to focus on this tiny supposed benefit instead of focusing on how to overcome a funding problem.

Everyone has funding troubles and that’s the problem you really want to fix, rather than trying to circumvent the obstacle by using the VA loan. If you get a VA loan and have no equity and no cash flow (since you’re living in it), how are you going to buy the next one? How are you going to survive economic turmoil? How are you going to get great returns? You’re going to trade all that, just to avoid saving for a down payment.

What do you think—is the VA loan useful for new real estate investors?

Weigh in with a comment!

About Author

Alexander Felice

Alex is a long distance single-family real estate investor and a full-time underwriter at a commercial bank. After a few years of success in real estate, he felt compelled to teach people real estate is more profitable than they might think and far less risky than they assume. Alex is the author of brokeisachoice.com

18 Comments

  1. Ramon Purifoy

    For a service member looking to get into real estate, it can be a very beneficial tool. Any property with any kind of financing needs to bought at the right price.

    I think some of your assumptions are pretty strong. If I could do it all over, I would definitely consider a small multifamily property with a VA loan. In a rental, what’s more important than your purchase price is your cashflow. Unlike a flip, you can buy at retail if the cashflow supports it. If I could get a triplex that retailed at 250k but cashflowed $1000 per unit, I’d definitely consider that.

    It’s also good for a creative financing. If you happen to have a seller that has a VA loan and you qualify, a loan assumption would be a consideration. With interest rates going up and VA loans typically having the lowest interest rates, this could be a good tool.

    Calling the VA loan a trap is a bit strong and misguiding in my opinion.

  2. David Krulac

    Alexander,
    I can understand how your experience buying that first condo has tainted your view. But it doesn’t have to be that way. I personally have bought and sold over 900 properties for my own inventory, plus have been involved in many more transactions for clients, both buyers and sellers. In addition, I have personally had SEVEN VA Mortgages, so I have had direct experience with the program. ALL SEVEN of the properties that I bought with VA mortgages made money. One was only a fair purchase but the rest were what I would consider to be pretty good.

    . Here’s a list of all eight properties:
    A. Bought $44,000 Previous Sale $52,300 Value $80,000
    B. Bought $81,000 Previous Sale $89,000 Sold $174,900
    C. Bought $32,000 Previous Sale $56,500 Sold $64,000
    D. Bought $67,400 Previous Sale $74,000 Sold $119,900
    E. Bought $61,000 Previous Sale $69,900 Sold $$111,000
    F. Bought $100,000 Previous Sale $104,000 Sold $176,000
    G. Bought $122,500 Previous Sale $128,000 Sold $154,500
    H. Bought $109,500 Previous Sale $98,900 Sold $119,900

    Total Bought $617,400 Previous Sale $673,500 Sold $1,000,200 Gross profit $382,800

    The last one was only fair, bought at peak market price and sold before market totally recovered. Only one was a condo, the rest were either townhouses or single family detached, none were multi-family. I’ve found in my personal experience that VA mortgages are more liberal on the property condition than FHA/HUD. None of these properties were in perfect condition and VA allowed the purchase to proceed. In every case except the worst case, I bought the property for LESS than the last previous sale. I try to negotiate the best price that I can going in and as they say, you make your money of the purchase.
    David Krulac
    Bigger Pockets Podcast Guest #82

    • Alexander Felice

      I’m glad it worked out for you! I’m sure it works for LOTS of people. That’s just not what my motive for the article was 😉

      to be honest, my first deal aint so bad and it certainly wasn’t the fault of the VA loan that it’s not great.

  3. Scott Houin

    I wanted to weigh in on a couple of things on this post. Also correct some information.

    1. The VA funding fee is exempt in two situations: a service connected disability of 10% or more not 30%; and if you are a surviving spouse.

    2. There is a funding fee on a VA loan, but that funding fee is way less then paying PMI on a FHA and/or conventional. In most cases this is true even if you pay upfront PMI.
    a. Although you can get a VA loan at 100% loan to value this is not required. Putting a down payment of 5% would significantly reduce the funding fee.

    Sometimes people don’t understand how to use the benefit which can cause problem like you pointed out with PCSing. One way I have seen my borrowers combat this is by renting to other service members.

    I have also purchased homes in other cities and have great property managers that work with me. I also have 1 insurance agent that handles all my properties. To this point i have not had issues maintaining these properties. It is important when using any financial tool that you understand the risks involved.

    Lastly, keep in mind the VA loan was not designed to purchase investment properties. It was designed for service members to use on their primary residence.

    Note: I have closed over 250 VA loans as a loan officer at Veterans United.

    Thanks,

    Scott- NMLS ID# 1245877

  4. Joe Arlt

    I live and work in Hampton Roads, Virginia, site of the world’s largest naval base, and I’ve bought many properties in many other military towns. I have owned hundreds of properties with VA loans. A couple were acquired through assuming such loans and the rest by buying them subject to the loans.

    From what I’ve learned over 20+ years, , Alex should have titled his article “Don’t buy a house with ANY loan if you’ll be PCS’g soon.” Because that is the real issue. I see it all the time. No matter how you financed, if you need to move a couple of years after buying you’re going to regret it. If you bought with 0% down VA you’ll be looking at renting it, doing a short sale, or selling it sub2 to me. (And those deals DO cash flow for me.). And if you put down 20% on a conventional loan you may not be upside down, but you’ll be losing a big chunk of that 20% to pay commissions and closing costs and repairs (paint and carpet, at least).

    Alex states that the VA loan program forces you to pay retail. No more than his recommended 20% down conventional loan program does! In either case, if it’s a junker (i.e. a good candidate for buying at a big discount) you’re not getting the loan. Conventional loan are a bit more lenient than VAs regarding condition, but not much.

    In any event, who says you have to pay full retail with a VA loan? They don’t send appraisers out to make sure you’re not paying too little! You can buy good deals from motivated sellers using VA loans just as easily as with conventional ones. For a while, anyway. Eventually you don’t qualify for any loans. But that is another issue.

    • Alexander Felice

      I would have loved to name it what you suggested, but it wouldn’t be as punchy 😉 😉

      My point wasn’t that the VA loan is bad, just that people use it as a starting point to design and investment strategy around and I think that’s a big mistake. Certainly not a career make or break!

      thanks for the comments!

  5. Joseph Delia

    I’m a former military officer and have bought many properties. I have NEVER used a VA Loan for one simple reason: Every single time I checked, I could find better rates elsewhere. If you need the benefits of no money down, then by all means use a VA loan to get yourself started, but overall I agree with the general sentiment of this article, that they are a bit of a “trap” (i.e., you can usually do better, if you have down payment money).

  6. Greg Groves

    Alexander,

    I agree that many service members purchase homes that do not make great rentals; however, I think your comments regarding the loans requiring the home to be “retail” are misleading. The home generally has to be livable, but that doesn’t mean pristine condition. VA’s can be used to purchase something on or off the MLS. My first VA purchase was a foreclosure that had been neglected for some time. My second VA purchase was another foreclosure, purchased via online auction, house was filled with trash, overgrown yard, etc.

    • Alexander Felice

      for sure, if you can find a great deal on a lightly distressed and discounted property AND use the VA loan then that would be ideal. I think those situations are rare, and it’s not good for anyone to pigeonhole themselves into using this strategy when it only works in very specific circumstances.

      I’m glad it worked for you, I’m sure the VA loan works for lots of people!

    • Alexander Felice

      It’s not that I don’t recommend the VA loan, it’s just a very limiting way to start. That can be fine though, that’s how I started!
      If you can buy in a market that is appreciating and the building will be a good rental once you move out, then it’s a great way to get your first building.

  7. John Murray

    I have never used my VA loan, I am going to use it to purchase my winter house or refinance one of my rental to move into. The positive is zero out of pocket and pull out as much equity as you want. The down side is one year owner occupied. Go Army!

  8. Nathan G.

    The problem with the VA loan is the buyer has very little skin in the game, if any. They think it’s an easy purchase with 100% financing but that’s only a good idea if they’re able to buy right. If they purchase at market – or close to it – they are starting off in the negative and a downturn in the market can ruin them. If they buy 10 – 20% below market, this could be a nice opportunity.

    I’m a big fan of fiscal responsibility and think it’s wiser to buy traditional with 20% down.

  9. Adam L.

    Every investment decision needs to be made with a thoughtful process. If someone jumps into the VA loan with the desire to have an investment property and doesn’t educate themselves on the correct ways to invest then of course they will end up in a hole. This goes the same way with any investment property and any loan type. If you get a ARM right now thinking you’re good to go without educating yourself you’ll end up in a world of hurt as well.

    To me, it is all about how you use the loan and the property. My partners and I teach people how to use the VA loan effectively and it is very possible! House hacking is probably the easiest way and by putting the extra cash back into the loan you can end up doing really well with paying off the principal by the time you PCS. Then… do it all over.

    Your article sounds like you should never use a VA loan for investments rather than some things to look out for. I hope everyone can get a good understanding of the benefits rather than be afraid to use it at all.

  10. Joel Hill

    Agreed. Its tough to get much cash flow out of a house with 0% down. Not saying it doesn’t happen, but it is that much more going to principle and interest every month. I used a VA loan on my first house that I lived in before PCS. If the market hadn’t appreciated as much as it has I’d be in a world of hurt. Things worked out and hopefully I’m wiser from it. It is worth mentioning a discounted house may have a tougher time making it pass the inspection for a VA loan.

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