Circular 26-18-6

Veterans Benefits Administration Circular 26-18-6

Department of Veterans Affairs April 5, 2018

Washington, D.C. 20420

Loans for Alteration and Repair

1. Purpose. This Circular replaces Chapter 7, Topic 4, Loans for Alteration and Repair, in the

Department of Veterans Affairs (VA) Lender’s Handbook, 26-7.

2. Background. VA has received inquiries regarding the procedures to process loans for

alteration and repair. The Aging housing stock in the United States has contributed to the

increased demand for alteration and repair loans. Due to the condition of this aged housing,

homes are often sold as “cash or conventional financing” which does not allow Veterans to use

their VA earned benefit. This guidance will allow Lender’s to make VA-guaranteed loans to

Veterans who wish to purchase or refinance a home that is in need of alteration and/or repair.

The terms alteration, repair, renovation, and improvement are interchangeable for the purposes

of this Circular.

3. Policy. VA may guarantee a loan for alteration and/or repair that allows improvements to

be included in the value and completed after closing of the loan. The loan proceeds are paid out

to the builder and/or contractor during the alteration/repair period. The lender must obtain

written approval from the borrower before each disbursement or draw payment to the builder

and/or contractor.

a. Eligible VA Loan Types. The types of alteration or repair loans eligible for VA guaranty

upon completion of the improvements are VA purchase loans, and VA regular (aka Cash-Out)

refinance loans. Alteration and repair loans must adhere to the VA Lender’s Handbook, 26-7,

Chapter 3.

(1) Loans for alteration and repair in conjunction with a purchase: this allows the Veteran to

purchase a home that needs improvement, or where the buyer wants to alter the home to their

preference. It is mandatory to use the lesser of the as-completed value, or the acquisition costs in

the transaction.

(2) Loans for alteration and repair in conjunction with a refinance of an eligible residence

already owned and occupied by the Veteran: this allows the Veteran to refinance the existing

loan and use the as-completed value in the transaction.

b. Credit and Underwriting. Loans for alteration and repair are underwritten in accordance

with the VA Lender’s Handbook, 26-7, Chapter 4.

c. Property Eligibility and Appraisals. The property and appraisal requirements for alteration

and repair can be found throughout the VA Lender’s Handbook, 26-7, Chapter 10 and 16. All

VA minimum property requirements (MPR), outlined in the VA Lender’s Handbook, 26-7,

Chapter 12, must be met prior to issuance of the Loan Guaranty Certificate (LGC) and the final

inspection/certificate of occupancy.

(LOCAL REPRODUCTION AUTHORIZED)

Circular 26-18-6 April 5, 2018

d. Eligible Alterations and Repairs. Eligible alterations and repairs must be those ordinarily

found on similar properties of comparable value in the community.

e. Acquisition Cost versus Value.

(1) Loans for alteration and repair in conjunction with a purchase must use the lessor of the

acquisition cost or the as-completed value determined by the VA fee panel appraiser. To

determine the acquisition costs for a purchase, add the following: Contract sales price, total cost

of alterations and repairs, contingency reserve (if any up to 15 percent of the repair cost),

inspection fees, title update fees, and permits.

(a) Contract sales price $100,000, alterations and repairs $75,000, contingency reserve of

$7,500, inspection $250, permit $250, for a total acquisition cost of $183,000. Notice of Value

(NOV) is $180,000. The lesser amount of $180,000 is to be used as the acquisition cost and the

borrower must bring $3,000 to closing. This is not considered downpayment as it is greater than

the value.

(b) Contract sales price is $100,000 alterations and repairs are $75,000, contingency reserve of

$7,500, inspection $250, permit $250, for a total acquisition cost of $183,000. Notice of Value

(NOV) is $190,000. The lesser amount of $183,000 is to be used as the acquisition cost.

Therefore, the entire acquisition cost of $183,000, plus the funding fee may be financed.

(2) Loans for alteration and repair in conjunction with a refinance must use the lessor of the

acquisition cost, or the as-completed value determined by the VA fee panel appraiser. To

determine the acquisition costs for a refinance, add the following: Existing loan payoff, total cost

of alterations and repairs, contingency reserve (if any up to 15 percent of the repair cost),

inspection fees, title update fees, and permits.

(a) Payoff is $200,000, alterations and repairs are $25,000, contingency reserve of $2,000,

inspection $250, permit $250, for a total acquisition cost of $227,500. NOV is $220,000. The

lesser amount of $220,000 is to be used as the acquisition cost and the borrower must bring

$7,500 to closing, or reduce the project costs and obtain a reconsideration of value based on the

adjusted alteration and repair costs.

(b) Payoff is $200,000, alterations and repairs are $25,000, contingency reserve of $2,000,

inspection $250, permit $250, for a total acquisition cost of $227,500. The NOV is $230,000.

The lesser amount of $227,500 is to be used as the acquisition cost and the borrower may finance

the entire project cost of $227,500. In addition, the borrower may finance closing costs, prepaids

or take cash-out, up to 100 percent loan to value.

(3) Contingency Reserve. A contingency reserve is not required, however, a lender should

consider a contingency reserve if the project warrants such a reserve. The maximum

contingency reserve is 15 percent of the alteration and/or repair cost. In a purchase, any unused

contingency reserve funds must be applied to the principal balance, unless it was paid in cash at

closing by the borrower. In such a case, it can be returned to the borrower. In a refinance, any

April 5, 2018 Circular 26-18-6

unused contingency reserve funds may be returned to the borrower or applied to the principal

balance at the borrower’s discretion.

f. Builder and Contractor Registration Requirements. For any property appraised for alteration

and repair, the builder, or contractor must have a valid VA builder identification number prior to

a VA NOV being issued. For information on obtaining a builder identification number see the

VA Lender’s Handbook, 26-7, Chapter 10. The builder or contractor must be registered with VA.

A list may be found at https://vip.vba.va.gov/portal/VBAH/Home. Instructions to become a

registered builder with VA can be found at

https://www.benefits.va.gov/HOMELOANS/appraiser_cv_builder_info.asp. Borrowers are free

to choose their builder or contractor, subject to any additional requirements the lender may

require. It is the lender’s responsibility to ensure that the builder or contractor is licensed,

bonded, and insured according to all state and local requirements.

g. The Process. The list below is a general guide for Lender’s to follow when processing a

VA Alteration and Repair loan. It is not meant to be inclusive of all steps.

(1) Verify Veteran eligibility in WebLGY (VA Lender’s Handbook, 26-7, Chapter 2)

(2) Qualify the borrower(s) (VA Lender’s Handbook, 26-7, Chapter 4)

(3) Determine the scope of the alteration and repairs (VA Lender’s Handbook, 26-7, Chapter 10)

(4) Order the appraisal as appropriate (VA Lender’s Handbook, 26-7, Chapter 10)

(5) Underwrite the loan (VA Lender’s Handbook, 26-7, Chapter 4)

(6) Issue the NOV (VA Lender’s Handbook, 26-7, Chapter 13)

(7) Close the loan

(8) Establish the draw account. The lender must deposit dedicated alteration / repair funds in a

custodial escrow account. These funds may not be comingled with other lender funds.

(9) Pay the funding fee within 15 days of loan closing (VA Lender’s Handbook, 26-7, Chapter 8)

(10) Work commences

(11) Funds are disbursed as progress is verified and approved by the Veteran

(12) VA MPRs are met (VA Lender’s Handbook, 26-7, Chapter 12)

(13) Certificate of Occupancy (if applicable)

(14) Final inspection by the VA fee appraiser signifies the end of the project (VA Lender’s

Handbook, 26-7, Chapter 14)

(15) Guaranty the loan (VA Lender’s Handbook, 26-7, Chapter 5)

h. Change Orders. Borrowers are permitted to pay for change orders and upgrade out of

pocket. Change orders/upgrades made after the appraisal cannot be mortgaged into the new loan,

unless the appraisal is updated. Change orders must be approved, in advance, by the appraiser,

to ensure there is no loss in value. If an appraisal is to be updated, the lender is responsible for

contacting the appraiser with the documented change order(s). The lender should contact the

Regional Loan Center (RLC) of jurisdiction for assistance, if needed. The Veteran is allowed to

pay an additional appraisal charge if change orders are requested. This additional appraisal

charge may come out of available contingency reserve funds.

i. Alteration and repair project management. The lender is responsible for all aspects of

establishing the account containing the alteration and repair funds. The lender must ensure that

Circular 26-18-6 April 5, 2018

funds are accounted for and disbursed according to the progress completed. The lender should

have the specialized experience to process, underwrite, close, and set-up the loan in progress

(LIP) account or draw account.

(1) Any remaining funds in the LIP account upon completion should be disbursed according to

the contract. If the remaining funds are the borrowers, re-imbursement is acceptable up to the

verified amount that has been paid in advance; otherwise the funds must be applied to the loan

balance.

(2) In addition, the lender has the responsibility to evaluate, monitor, and manage the project.

It is the lender’s responsibility to ensure that the project is completed per the plans,

specifications, and /or contract documents, so that the value of the home is preserved.

(3) When a project is primarily cosmetic (i.e. carpet, paint, minor repairs) and does not require

permitting and inspection from the local authority, the lender may condition the NOV for lender

certification “or” may condition for appraiser reinspection/certification. Lender certifications in

these cases reduce, days to finalize loans and obtain guaranty and/or may promote financial

savings (i.e. reinspection fees) benefiting Veterans.

(4) If the project requires permitting and local authority inspections or requires detailed

construction exhibits to be provided to the appraiser, the lender “must” condition the NOV for

appraiser reinspection/certification. This ensures compliance with exhibits and information used

in the preparation of the subject’s valuation.

(5) Specifications for materials to be used in projects must be provided to the appraiser for

consideration in the preparation of the appraisal report. If renovations require permits and local

authority inspection and/or require building plans, these exhibits along with any materials

specifications “must” be provided to the appraiser at the time of appraisal order to be utilized in

the preparation of the appraisal report for valuation purposes. Appraisers will “hold” appraisal

assignments until the appropriate exhibits are received. The appraiser should contact the point of

contact (POC) if not received within one day of appraisal order and “must” put notes in the case

in WebLGY.

(6) Any re-inspections by the appraiser must ensure that the completed renovations meet at

least the minimum specifications originally utilized in preparing the appraisals final value. The

use of any lower grade materials or deviations that may lower the original value provided in the

appraisal report must be noted as to the specific deviation and its impact.

j. Fees and Charges. Lender’s may charge the Veteran a construction fee of up to two percent

of the amount of the loan for its services, provided that the majority portion (51 percent or more)

of the loan proceeds are paid out by the lender during the actual progress of the construction,

alteration, improvement, or repair. Such charges may be in addition to the one percent

origination charge. If the portion of disbursed proceeds for services is less than 51 percent, a one

percent or less construction fee is permissible in addition to the one percent origination charge.

April 5, 2018 Circular 26-18-6

(1) Fees charged on the loan guaranteed by VA must comply with the VA Lender’s Handbook,

26-7, Chapter 8.

(2) The funding fee is due and payable to VA within 15 days of loan closing. It is not tied to

the commencement or completion of construction.

(3) Loans must be reported to VA within 60 days of receipt of a clear VA final inspection

report.

(4) In an alteration/repair purchase, for the purpose of reducing the funding fee, a down

payment will only apply to the extent that the loan amount is based off of the lessor of the NOV

or the acquisition cost.

(5) In an alteration/repair refinance, for the purpose of reducing the funding fee, equity will

count only to the extent that the loan amount is less than the NOV.

k. Inspections. Improvements must be completed according to local building codes. The

options allowable to satisfy the inspection requirement for cases ordered as r of the NOV or

(1) If the local authority performs the required inspections and issues a Certificate of

Occupancy (CO) or equivalent, VA will accept the CO for the property as evidence of local

authority inspections and satisfactory completion of construction. Loans for alteration and repair

ordered as “Proposed” require local authority inspections according to the extent of the

improvements and local requirements.

(2) If the local authority performs the required inspections, but does not issue a CO or

equivalent, VA will accept copies of the inspection reports, which verify full compliance with

local builder codes, or a written statement from the local authority that states that the required

inspections were performed in a satisfactory manner.

(3) Final inspection: When the property is 100 percent complete, the lender will contact the

original VA fee appraiser to complete the VA final repair inspection. If the original VA fee

appraiser is not available, the lender will contact the RLC of jurisdiction for another VA

appraiser to complete the VA final inspection. Note: The VA final inspection is to certify all VA

MPRs have been met and the house was improved according to the original plans, specifications,

approved change orders, and the as-completed value from the appraisal was maintained.

(4) It is the lender's responsibility to negotiate an inspection schedule with the builder or

contractor, and it is the lender's responsibility to ensure it is followed.

l. Guaranty. The guaranty for alteration and repair loans will not be issued until a clear final

inspection report has been completed by the VA fee appraiser.

Note: Contact the Government National Mortgage Association (GNMA) for pooling eligibility

questions.

Circular 26-18-6 April 5, 2018

(1) If the improvements are not fully completed and loan proceeds are not fully disbursed, the

guaranty will apply only to the proper pro rata part of the loan.

4. Rescission. This Circular is rescinded April 1, 2020.

By Direction of the Under Secretary for Benefits

Jeffrey F. London

Director, Loan Guaranty Service

Distribution: CO: RPC 2021

SS (26A1) FLD: VBAFS, 1 each (Reproduce and distribute based on RPC 2021)