This So-Called Perk of a VA Loan Could Actually Be a Major Drawback

In April, the average existing home sold for $407,600, according to the National Association of Realtors. If you intend to make a 20% down payment on a home costing that much to avoid private mortgage insurance, you need to come up with $81,520. That's not exactly an easy ask.

Many conventional mortgage lenders will let you put down less than 20% on a home. You may be able to get away with only 5% down. For a home listed for $407,600, 5% amounts to $20,380.

But let's also be real -- a lot of people don't have $20,000 and change in their bank accounts these days, especially given how expensive it's gotten to live. If only there were a way to buy a home with no money down.

Actually, there is. If you're a former or current member of the U.S. military, you may be eligible to take out a VA loan. And there's a unique feature of VA loans -- they don't require a down payment.

You may be eager to buy a home with no money down. And if you can afford the monthly mortgage payments, you might assume there's nothing wrong with doing so. But buying a home with $0 down could backfire on you.

When circumstances change

On the one hand, it's nice that VA loans don't require you to make a down payment. On the other hand, a $0 down payment means you're starting off homeownership with zero equity in your home.

If home values drop and your financial situation also gets worse at the same time, you could end up at risk of foreclosure due to being underwater on your mortgage. This happens when you can't sell your home for a high enough price to pay off your mortgage in full.

So let's say you buy a $300,000 home this month with no money down. If you can afford the monthly payments, you might assume you're in good shape.

But what if you lose your job in two years, or you're forced to take an unpaid leave of absence from work and are no longer able to afford your mortgage payments? In that case, if your home is still worth $300,000 or perhaps a little more and you owe a little less than $300,000 on your mortgage, you could conceivably sell it, pay off your lender, and move on.

Where you run into trouble is if home values are down at the time. If your home is only worth $260,000 in two years but you owe roughly $285,000 on it because you've only been making payments on your $300,000 mortgage for a couple of years, you're $25,000 short of being able to pay off your lender.

At that point, you risk getting foreclosed on. Granted, your lender might also agree to a short sale, where you sell your home for what you can get and the lender writes off the remainder of your mortgage balance. But a short sale, like a foreclosure, can stay on your credit report for up to seven years, making it difficult to get approved for other loans during that time.

Consider making a down payment if you can

It can be tempting to buy a home with no money down with a VA loan. But starting off with no equity whatsoever can be bad if housing market conditions decline or your financial situation worsens. Even if you're interested in signing a VA loan, you may want to put some money down if you can afford to.

Making a down payment doesn't just help you start off with equity. It could also lead to a lower upfront fee known as a funding fee, which is a cost you bear any time you sign a VA loan.

If you're signing your first VA loan and make a down payment of less than 5%, you're charged a funding fee equal to 2.15% of your loan amount. But if you put down 5% to under 10%, that fee drops to 1.5%. And if you put down 10% or more, it goes down to 1.25%. So if you have the money to put down, it could result in nice savings on your loan right off the bat.