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This is a guest post from Jules “Jay” Hurst, a Real Estate Agent in Washington, DC. Personally, I find real estate too stressful to own while on active duty and advise most military servicemembers to rent while on active duty. I prefer my investments simple, low cost, automatic, and diversified.
That said, I like hosting different opinions on my site to increase your knowledge and decide on your own path to financial independence. Many active duty servicemembers and veterans have become financial successful through property ownership. Rich Carey is one of them.
Millennials continue to have lower rates of home ownership than previous 20th century generations at the same age. Larger educational debts, delayed household formation, and the rapid increase in urban housing prices have all slowed Millennial home purchases.
Despite the financial success of Millennial households, these three factors have made it more difficult for Millennials to save the down payments necessary to buy a home.
Veterans have a leg up on other Millennial buyers. Their access to a mortgage backed by the Department of Veteran Affairs (VA) allows them to purchase homes without a down payment because the VA guarantees 25% of the loan.
In a world of $500,000 condos, that makes a big difference! You can probably already tell that the VA Loan is an amazing benefit, but if you are pursuing financial independence in an expensive area, how do you get the most out of it?
Here's a tip:
Inner-City VA Loan House Hack
Since the Great Recession, you have probably noticed that the nation’s largest metro areas have seen housing prices sky-rocket. There are a multitude of causes.
Permitting costs have driven developers to focus on luxury homes, apartments, and condominiums and housing construction has lagged as the economy regained its footing after 2008.
Perhaps most importantly, as the economy began to grow jobs again, many of the gains occurred in cities with shortages of housing stock. Housing demand in many urban areas dwarfs housing supply.
In my market in Washington, DC, the median price of a townhome is $752,300! For an FHA loan that’s a $26,330 down payment without factoring in closing costs (3.5% down). For a conventional loan, that’s a whopping $150,460 (20% down) before closing costs.
If you qualify for a VA Loan, these terrifying down payment numbers aren’t a concern for you. Find a house conducive to having roommates (lots of bedrooms/bathrooms, appropriate layout) and live with your friends.
When you don’t want to live with roommates anymore, just move out and rent the room you were sleeping in. This will allow you to buy a house at the limit of your budget and still save money every month. If you don’t ever want roommates, find a property with an English basement, separate apartment, or other area you can rent out.
A $750,000 house with 4 bedrooms will run you about $5000 a month at 4% interest, including taxes/insurance. Rent out three of the bedrooms for $1000 to $1400 a month and you will still find yourself paying less than you would for a one-bedroom apartment in many cities. At the end of the day, all the equity returns to you.
Even a low appreciation rate can generate wealth on an expensive property:
|2% Annual Appreciation||4% Annual Appreciation||8% Annual Appreciation|
After you buy a house, you make money one of three ways:
- It generates cash flow from rent.
- It appreciates, or…
- You recover equity by paying down your loan.
The numbers above don’t reflect any income from cash flow or paying down the loan. This is all appreciation. With such an expensive house ($750k), you can make a large amount of money if the house appreciates at a rate that parallels inflation.
If it drastically exceeds inflation, a single house can fund a significant portion of your retirement or expedite your path to financial independence.
But how do I know the house won’t lose value?
You don’t. Price appreciation is not guaranteed. However, if you buy a home in a metro area with a good economic base and hold it for the long-term, you’ll probably do just fine.
There are plenty of homeowners in Los Angeles, San Francisco, Seattle, Portland, DC, New York City, and other metro areas who purchased property at the height of the market in 2006 who are happy they own them today. Until land, labor, or building materials begin getting cheaper each year, I’ll bet on appreciation and inflation.
Just for the sake of argument, let’s assume your house doesn’t gain a dime for ten years. You purchased it for $750,000 in 2018 and it’s still worth the same amount in 2028.
On a $750,000 mortgage you will pay off over $1,000 of principal every month. In the first year of the mortgage alone, you can expect to pay off over $13,000 of principal. After ten years of making payments, you will pay off over $178,000!
But wait, aren’t there limits on how large VA Loans can be?
Yeah, there are…but only for another four months!
On June 25th, 2019 President Trump signed the Blue Water Navy Vietnam Veterans Act of 2019 into law, removing limits on the size of mortgages available to Veterans without a down payment. Effective January 1st 2020, the Department of Veteran Affairs (VA) will guarantee 25% of a mortgage of any size!
Previously, U.S. Code guaranteed 25% of a VA-backed mortgage up to the Freddie Mac conforming loan limit. Freddie Mac’s conforming loan limits vary by county, from $484,350 in less expensive areas like Montgomery, Alabama to $726,525 in expensive areas like Washington, DC. In the past, if Veterans wanted to exceed the conforming loan limit, they had to make a down payment for the portion of the loan not guaranteed by the VA.
The Blue Water Navy Vietnam Veterans Act eliminates the requirement for the loan to remain under the conforming loan limit. If the Veteran can qualify for the loan, the VA will guarantee 25% of it.
What does this mean in practical terms? Here is an example.
Imagine you are attempting to buy a house in Washington, DC for $1,000,000 with a VA loan. Under the old system, this loan would exceed the conforming loan limit by $273,475. The Veteran would need to make a down payment of $68,368.75 (25% of the portion of the loan not guaranteed by the VA) to secure the mortgage.
1,000,000 – $726,525 (loan limit) = $273,475
Down Payment Required = $273,475 x 25 % = $68,368.75
Under the new law, the VA will guarantee 25% of the entire $1,000,000 loan amount. You don’t have to put anything down.
Rinse and Repeat
Here’s another great thing about VA-back mortgages. You can use them more than once! If you prove to the Department of Veteran’s Affairs that you have sold all property that you have purchased with a VA-backed loan and paid your loans in full, the VA will restore your full entitlement.
You can also regain your entitlement for one-time additional use if you refinance your mortgage out of a VA-backed loan into a conventional loan.
Under the Blue Water Navy Vietnam Veteran’s Act of 2020 that means you could potentially buy a $750,000 house in an expensive metro area and then refinance it into a conventional loan.
Then, you would gain your eligibility back to buy another expensive house with no money down again! You will have to pay fees and closing costs for the refinance, but that’s still way cheaper than a 20% down payment.
Funding Fees and Closing Costs
Unless you’re an exempt Veteran, you will still have to pay the VA’s funding fee. At current interest rates, I advise most of my clients to roll this into the cost of the loan.
At 4% interest, you can finance $10,000 amortized over 30 years for $47 a month. Financing your funding fee won’t break the bank. Besides, it frees up that money for other investments or unexpected events. Life happens.
Unfortunately, you cannot finance your closing costs, but you can ask the Seller to pay them for you. If you really need someone to pay your closing costs, then tell your Real Estate Agent promptly.
You can generally offer the Seller a higher price for the house in exchange for them covering your closing costs (You will need the house to appraise for enough to accommodate the higher price).
The math works out the same for them. I recently helped a friend buy a house for the cost of the home inspection and appraisal fee (~$1000). The Seller paid his closing costs and he financed his funding fee.
So, there you have it, just one way to get the most out of your VA Loan on your journey to financial independence.
If you’re a Millennial, most of your peers will spend years saving to buy a house in expensive metro areas. You don’t have to wait!
Jules “Jay” Hurst is Real Estate Agent at Quasar Real Estate in Washington, DC who specializes in helping fellow Veterans. Feel free to send him an email at [email protected] or call his office at (301) 279-0494.
*Remember, every real estate transaction is different. Speak with a professional about your specific circumstances.