VA Lenders Handbook (VA Pamphlet 26-7), Chapter 7, Topic 2 — Construction/Permanent Home Loans
VA Lenders Handbook (VA Pamphlet 26-7), Chapter 7, Topic 2 — Construction/Permanent Home Loans.
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VA Lenders Handbook (VA Pamphlet 26-7), Chapter 7, Topic 2 — Construction/Permanent Home Loans
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§Topic 2. Construction/Permanent Home Loans Change Date: June 5,…3,679 ch
Topic 2. Construction/Permanent Home Loans Change Date: June 5, 2024 This Chapter has been revised in its entirety. a. The Basics VA may guarantee a loan for the construction1 of a home to be owned and occupied by the Veteran. VA permits one-time and two-time construction loans. Construction loans (one-time or two-time) may also be refinanced under VA’s cash-out refinance guidelines. This section specifically addresses construction loans and does not apply to the purchase of a newly built home financed by a builder (such as those commonly found in Planned Unit Development communities) or cash-out refinances. All construction and cash-out refinancing loans are subject to VA’s underwriting requirements2 outlined in Chapter 4. Once the VA construction loan type, one-time or two-time, is closed it cannot be modified into another loan type. That is, a one-time close cannot be turned into (converted) a two- time close or vice versa. One-time and two-time construction loans may be considered purchases in VA’s systems regardless of the category stated on the loan application, closing disclosure, or whether or not the borrower already owns the land. Note this is for VA purposes and may not match Real Estate Settlement Procedures Act requirements (RESPA). One-Time Close Construction or VA Construction to Permanent Loans. These types of loans are used to close the construction financing and permanent financing at the same time. The permanent financing is established prior to construction, and the final terms are modified to the permanent terms at the conclusion of construction. Two-Time Close Construction Loans. These types of loans involve an initial non-VA interim construction loan that closes prior to the commencement of construction and a second loan closing, where a VA-guaranteed loan is used to establish permanent financing by refinancing the interim construction loan. Interim construction financing does not include Home Equity Lines of Credit (HELOCs) or loan vehicles that already provided for permanent financing such as a one-time construction loan. Cash-Out Refinance Loans. These types of loans involve the refinancing of any existing lien indebtedness. Unlike the one-time or two-time construction loan, the Veteran may obtain cash-out through the transaction. These loans are subject to VA’s Cash-Out Refinance Requirements3 and may not exceed 100% of the VA reasonable value. Note that satisfaction of an interim construction loan is considered a net tangible benefit for the purpose of a cash- out refinance. b. Builder Identification (ID) Number The Veteran may choose their own builder and a VA Builder ID must be obtained prior to the issuance of the Notice of Value (NOV). The Veteran may act as their own contractor or builder, and VA Builder ID is not required in these cases. Refer to Chapter 10 for additional information. A list of registered VA builders is available for lenders in the VA LGY HUB https://lgy.va.gov/lgyhub/. Information on obtaining a VA Builder ID number is available on our website: https://www.benefits.va.gov/HOMELOANS/appraiser_cv_builder_info.asp. c. Property Eligibility and Appraisals One-time construction loans: appraisals should be ordered before the completion of the foundation as a purchase, specifying the loan use as "Construction to Permanent" and building status as "Proposed". Construction exhibits, permitting, and materials specifications, should be provided to the appraiser at the time of the appraisal order for preparation of the appraisal report for valuation purposes. Appraisers will hold appraisal assignments until the appropriate exhibits are received. Two-time construction loans:
1Appraisals should be ordered when the dwelling is 100% complete…170 ch
(1) Appraisals should be ordered when the dwelling is 100% complete. The appraisal should be ordered as a purchase, specifying the building status as "New Construction".
2While VA prefers for the appraisal to be ordered after the…4,221 ch
(2) While VA prefers for the appraisal to be ordered after the dwelling is 100% complete, if the appraisal is being ordered prior to completion, the lender will need to order the appraisal as a purchase, specifying the loan use as "Construction to Permanent" and the building status as "Proposed." Construction exhibits, permitting, and materials specifications, should be provided to the appraiser at the time of the 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. Cash-Out Refinances: Transactions in which construction was completed and at least one year has passed, as evidenced by a Certificate of Occupancy (CO) or other evidence by the taxing authority, are treated as cash-out refinances if the Veteran already owns the property. The appraisal should be ordered as a "VA Cash-Out Refinance" in WebLGY. Construction exhibits such as plans, specifications, and contracts are not required. d. Maximum Loan Amount The maximum loan amount for construction (one-time and two-time) loans is limited to: (1) the lesser of the VA reasonable value or the acquisition costs (described in section e), plus, (2) the applicable VA funding fee. Cash-Out Refinance Loans may not exceed the VA reasonable value. See Chapter 3 for additional details on maximum loan amounts. e. Acquisition Costs One-Time Close: Acquisition costs on a one-time construction loan include the following, provided documentation is submitted to support the associated amount: (1) the contract to build (2) balance owed on the land (3) interest reserve, if not included in the contract to build (4) contingency reserve (5) permits, if not included in the contract to build If the Veteran acts as their own contractor, all labor and material costs must be documented by receipts, work orders, and/or contractual agreements to establish the contract price. If no balance is owed on the land neither the original cost nor current value may be included in the acquisition cost. Two-Time Close: Acquisition costs on a two-time construction loan include the following, provided documentation is submitted to support the associated amount: (1) balance of the interim construction loan, and (2) balance owed on the land If no balance is owed on the land neither the original cost nor current value may be included in the acquisition cost. f. Loan Guaranty Certificate and Maximum Guaranty Amount Although the loan will normally be considered guaranteed upon closing, the Loan Guaranty Certificate (LGC) on a construction/permanent home loan will not be issued until a clear post construction inspection report has been received by VA. All NOV requirements, including the Post Construction Inspection by the appraiser must be met prior to the issuance of the LGC. VA construction loans are eligible to receive the same guaranty amount and percentage as VA purchase loans4. See Chapter 3 for additional information. g. Funding Fee and Loan Reporting The funding fee is due and payable to VA within 15 days of loan closing5; this requirement is not tied to the commencement or completion of construction. Although evidence of guaranty is not issued until construction is complete, VA will not approve a funding fee refund if the lender fails to obtain evidence of guaranty or for the fact that the Veteran sold the property before the completion of construction. The loan must be guaranteed in WebLGY within 60 days6 of receipt of the clear post construction inspection report and completion of all NOV requirements. For one-time and two-time construction loans: In some instances, equity in the subject property may be considered as a downpayment for the purpose of reducing the funding fee. (1) Equity in the secured property may be used as a down payment for calculating the funding fee, or (2) In cases where the Veteran purchased the land within one year of VA loan closing, the greater of the amount paid to acquire the land or the value of the land (if the appraiser assigned value to the land on the appraisal) may be considered as a downpayment for the purpose of calculating the funding fee, or (Section u, Table 8)
3In cases where the Veteran purchased the land more than one year…455 ch
(3) In cases where the Veteran purchased the land more than one year prior to the VA loan closing, the value of the land may be considered for the purpose of calculating the funding fee if the appraiser assigns value to the land on the appraisal. If the appraiser does not assign value to the land on the appraisal, equity in the subject property may be considered as a down payment for the purpose of calculating the funding fee, or (Section u, Table 9)
4In cases where the Veteran obtained the land as a gift, only…3,030 ch
(4) In cases where the Veteran obtained the land as a gift, only equity in the subject property may be counted as a downpayment for the purpose of calculating the funding fee. (Section u, Table 10) Detailed examples are provided in Section u. Simple equity example: A borrower is using a VA (one-or two-time) construction loan to construct a dwelling on land owned for more than one year prior to the VA loan closing. The VA financing will close on March 15, 2023. The reasonable value is $400,000, and the loan amount is $350,000. The purchase price in the Funding Fee Payment System (FFPS) should be entered as $400,000 and the equity in the secured property, $50,000 ($400,000 - $350,000), should be entered as the down payment. FFPS will automatically calculate the required funding fee of $4,900 (1.40%). Note: Equity in the secured property cannot be used as a down payment for VA cash-out refinance transactions. See Chapter 8 for additional details on the VA Funding Fee. h. Fees and Charges the Veteran Can Pay Fees and charges the Veteran can pay are described in Chapter 8. Note that permissible fees differ for one-time and two-time construction loans, and that an increased flat fee may be charged on one-time construction loans where the lender supervised the progress of construction and/or makes advances to the Veteran during construction. On one-time close construction loans, the Veteran may not pay any fees or charges that are the builder’s responsibility. The Veteran may pay for interest not included in the interest reserve, and/or interest due after the initial interest reserve is depleted to prevent loan default. i. One-Time Construction Loan Process This loan type may also be called a construction to permanent loan and closes prior to the start of construction simultaneously providing both the construction loan and permanent financing. Loan proceeds may be disbursed to cover the cost of, or balance owed on the land, with the remaining balance deposited into an escrow account, commonly referred to as a Draw or Loan in Process (LIP) account. Escrowed funds are then paid out to the builder during construction. The lender must obtain written approval from the borrower before each draw payment is provided to the builder. The lender must also retain this in the loan file and provide to VA upon request. Lenders should have the specialized experience to originate, process, underwrite), close, service and administer such loans. These types of loans and projects inherently have uncertain elements that require careful examination. The following provides a general guide for lenders to follow when processing a VA one-time construction loan. (1) Verify the Veteran’s eligibility and entitlement. (Chapter 2) (2) Order the appraisal as a purchase, specify the loan use as "Construction to Permanent" and the building status as "Proposed" and provide all necessary documentation. (Chapter 10) (3) Issue the NOV. (Chapter 13) (4) Underwrite the loan using VA’s underwriting guidelines. (Chapter 4)
5Close the loan, disburse monies to cover the cost of the land and…122 ch
(5) Close the loan, disburse monies to cover the cost of the land and fund the construction escrow (LIP or Draw) account.
6Pay the VA Funding Fee within 15 days of loan closing. (Chapter 8)71 ch
(6) Pay the VA Funding Fee within 15 days of loan closing. (Chapter 8)
7Construction takes place, disburse funds in accordance with any…171 ch
(7) Construction takes place, disburse funds in accordance with any established draw schedule after obtaining the Veteran’s written approval before making such a payment.
8The final inspection report signifies the end of the project66 ch
(8) The final inspection report signifies the end of the project.
9Modify the loan in accordance with the terms of the loan62 ch
(9) Modify the loan in accordance with the terms of the loan.
10Issue the Loan Guaranty Certificate after all NOV requirements…13,009 ch
(10) Issue the Loan Guaranty Certificate after all NOV…3,464 ch
(10) Issue the Loan Guaranty Certificate after all NOV requirements are met. (Chapter 5). j. Account Management and Contingency Reserve (one-time close) Contingency reserve funds will be negotiated between the borrower and builder. The lender is responsible for all aspects of establishing the account containing the construction funds. The lender should ensure that funds are accounted for and disbursed according to the progress completed. Escrowed funds will be used for their stated purpose. Any funds remaining in the LIP account upon completion of construction should be disbursed according to the contract. Excess construction or reserve funds may be returned to the borrower up to the verified amount that has been paid in advance, otherwise, the funds should be applied to the loan balance. Note: The application of excess funds to the loan balance does not impact calculation of the funding fee or final guaranty amount. The lender should retain evidence of the principal balance reduction in the loan file. k. Amortization (one-time close) The Veteran begins making payments on a one-time construction loan when construction is complete. Therefore, the initial payment on the principal may be postponed up to one year, if necessary. If construction cannot be completed within 12 months7, payments may be delayed, on a monthly basis for up to an additional six months. The loan must be amortized to achieve full repayment within its remaining term. The lender must provide evidence of the amortization in the loan file. The maximum term on a VA-guaranteed loan is 30 years and 32 days8. Example. If it takes six months to complete construction, the payment schedule for the Veteran obtaining a 30-year mortgage must provide for full repayment of the loan in 29 years and six months. VA requires amortization with approximately equal payments and the principal must be reduced at least once annually, this includes construction loans. However, the final installment may be for an amount up to five percent of the original principal amount of the loan9. Rather than requiring a balloon payment, it may be preferable to set up equal payments (beginning after construction is complete) which are large enough to repay the loan within the original maturity without a balloon payment. l. Change Orders (one-time close) Change orders should be reviewed in advance by the appraiser to ensure no loss in value. Change orders/upgrades made after the appraisal cannot be mortgaged into the loan unless an updated appraisal is obtained. The additional appraisal fee may come out of available contingency reserve funds, or borrowers are permitted to pay for upgrades out of pocket. If an updated appraisal is required, the lender is responsible for contacting VA Construction and Valuation for assistance and for providing the documented change order(s). Requests should be made through the ServiceNow portal accessible at https://www.benefits.va.gov/HOMELOANS/contact.asp. Note: lenders must maintain change orders and appraisal invoices in the loan file. m. Inspections (one-time close) NOV requirements for both Post Construction Inspections and Proposed Construction Inspections and Warranties must be met if conditioned on the NOV. Proposed Construction Inspections: Construction should be completed according to local building codes. There are three options allowable to satisfy the proposed construction inspection requirement for cases ordered as "Proposed."
1If the local authority performs the required foundation, framing,…363 ch
(1) If the local authority performs the required foundation, framing, and final 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. Please note that framing inspection is not required on manufactured or modular homes.
2If the local authority performs the required foundation, framing,…356 ch
(2) If the local authority performs the required foundation, framing, and final inspections but does not issue a CO or equivalent, VA will accept copies of the inspection reports, which verify full compliance with local building codes, or a written statement from the local authority confirming that the required inspections were performed satisfactorily.
3If the local authority does not perform the required inspections,…4,442 ch
(3) If the local authority does not perform the required inspections, the property should be covered by a 10-year insured protection plan that is acceptable to the Department of Housing and Urban Development (HUD) and a 1-year VA builder’s warranty. Post-Construction Inspection. When the property is 100 percent complete, the lender will contact the original VA fee appraiser to complete the VA final inspection. If the original VA fee appraiser is not available, the lender must contact VA Construction and Valuation by submitting a request through the VA ServiceNow portal (link available in Appendix A) for another VA fee appraiser to complete the VA final inspection. The VA final inspection is to certify that all VA Minimum Property Requirements (MPR) are met, and the house was built to the original plans, specifications, and approved change orders, and that the as-completed value from the appraisal was maintained10. It is the lender's responsibility to negotiate an inspection schedule with the general contractor, and it is the lender's responsibility to ensure the schedule is followed. Refer to Chapter 10 for additional information on post-construction inspection reports. n. Interest Rate (one-time close) Lender’s may offer a "ceiling-floor" where the Veteran "floats" the interest rate during construction. The agreement must provide that at lock-in, the permanent interest rate will not exceed a specific maximum interest rate and permit the borrower to lock-in at a lower rate based on market fluctuations. Lock-in agreements should be maintained in the loan file and provided to VA upon request. The borrower(s) must qualify for the mortgage at the maximum rate. o. Project Management (one-time close) The lender is responsible for evaluating, monitoring, and managing 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. p. Fees the Veteran Cannot Pay (one-time close) On a one-time construction home loan, the builder is responsible for all fees normally paid by a builder who obtains an interim construction loan including, but not limited to: (1) inspection fees (2) title updates, and (3) hazard insurance during construction. Note: In the case of a two-time construction loan, the VA loan is not established prior to the commencement of construction, therefore the terms of the initial construction loan, and the fees to be paid by the builder, are subject to negotiation. q. What if Construction Is Not Fully Completed and Loan Proceeds are not Fully Disbursed? (one-time close) If the construction is not fully completed and loan proceeds are not fully disbursed, the guaranty11 will apply only to the proper pro rata part of the loan. To calculate the proper pro rata part of the loan: (1) take loan proceeds disbursed for construction purposes, (2) add any other payments made to the builder by or on behalf of the Veteran, (3) take the lesser of the above total or 80 percent of the value of that portion of the construction completed, and (4) add any loan disbursements made for the purchase of the land on which the construction is situated. The lender must also certify that any amounts advanced for land is protected by title or lien and that no enforceable liens, for any work done or material furnished for that part of the construction completed and for which payment has been made out of proceeds of the loan exists or can come into exitance. In the event circumstances make it impracticable to complete construction and fully disburse funds, the lender should contact VA for additional information on obtaining a partial guaranty. r. Two-Time Construction Loan Process This loan type involves the refinance of a non-VA interim construction loan with a VA- guaranteed loan. Interim construction loans are construction loans that do not provide for permanent financing. The following provides a general guide for lenders to follow when processing a VA two- time construction loan. As VA prefers for the appraisal on a two-time construction loan to be ordered after the dwelling is 100% complete, this general guide does not address instances where the lender orders the appraisal prior to completion of the dwelling. (1) Verify the Veteran’s eligibility and entitlement. (Chapter 2) (2) Close the non-VA interim construction loan. (3) The construction takes place.
4Order the VA appraisal after construction is complete as "New…94 ch
(4) Order the VA appraisal after construction is complete as "New Construction." (Chapter 10)
5Issue the NOV. (Chapter 13)32 ch
(5) Issue the NOV. (Chapter 13)
6Underwrite the loan using VA’s underwriting guidelines. (Chapter…72 ch
(6) Underwrite the loan using VA’s underwriting guidelines. (Chapter 4)
7Close the loan after all NOV requirements are met. (Chapter 5)67 ch
(7) Close the loan after all NOV requirements are met. (Chapter 5)
8Pay the VA Funding Fee within 15 days of loan closing. (Chapter 8)71 ch
(8) Pay the VA Funding Fee within 15 days of loan closing. (Chapter 8)
9Issue the Loan Guaranty Certificate. (Chapter 5) s. Construction…4,048 ch
(9) Issue the Loan Guaranty Certificate. (Chapter 5) s. Construction Complaint Process VA assistance with construction complaints will be limited to defects in equipment, material, and workmanship reported during the required 1-year VA builder’s warranty period. t. Construction Loan Comparison Table 7: Comparison of VA Construction Loan Types and Cash-Out Refinance Loans Loan Feature One-Time Close Two-Time Close Cash-Out Refinance Appraisal Timing Prior to Commencement of Construction Preferred: After Dwelling is 100% Complete Preferred: After Dwelling is 100% Complete Purchase or Refinance for VA Purposes Purchase Purchase Refinance Appraisal Type Proposed – Per Plans and Specs Preferred: Built Less than One Year and Never Occupied Refer to Chapter 10 Maximum Loan Amount Lesser of: a. Acquisition Cost, or b. VA Reasonable Value. Plus, the applicable VA Funding Fee Lesser of: a. Acquisition Cost, or b. VA Reasonable Value. Plus, the applicable VA Funding Fee 100% of the Reasonable Value Cash to Veteran Acceptable? No No Yes, the Veteran may receive proceeds from the loan and/or satisfy other debts Can Equity be Considered for VA Funding Fee Rate Reduction? Yes Yes No Do VA’s refinancing NTBs apply? No No Yes (The refinance of an interim construction loan is an NTB.) u. Funding Fee Downpayment Examples This section provides examples of construction loan downpayment scenarios and the appropriate amount to enter into FFPS as the Purchase Price and the Downpayment amount. Table 8: Construction Loans – Veteran Purchased the Land Within One Year of Close Lenders should use this table in cases where the Veteran purchased the land within one year of closing of the VA-loan. Item Description Example 1 Example 2 Example 3 A Cost to Acquire Land $100,000 $30,000 $100,000 B Balance Owed on Land $0 $20,000 $60,000 C Contract to Construct + Permits and Reserves (if applicable) $300,000 $300,000 $300,000 D Acquisition Cost (B+C) $300,000 $320,000 $360,000 E Reasonable Value (Per NOV) $350,000 $375,000 $500,000 F Land Value (if given) n/a $80,000 n/a G Max Loan Amount (Lesser of D or E) $300,000 + applicable FF $320,000 + applicable FF $360,000 + applicable FF H Purchase Price in FFPS (Greater of: E., (A+C), or (C+F)) $400,000 $380,000 $500,000 I Downpayment in FFPS (H-G) $100,000 $60,000 $140,000 Table 9: Construction Loans – Land Purchased More than One Year Before Close Lenders should use this table in cases where the Veteran purchased the land more than one year prior to the closing of the VA-loan. Item Description Example 1 Example 2 Example 3 A Cost to Acquire Land n/a n/a n/a B Balance Owed on Land $0 $60,000 $0 C Contract to Construct + Permits and Reserves (if applicable) $300,000 $300,000 $300,000 D Acquisition Cost (B+C) $300,000 $360,000 $300,000 E Reasonable Value (Per NOV) $350,000 $350,000 $350,000 F Land Value (if given) Not Given Not Given $75,000 G Max Loan Amount (Lesser of D or E) $300,000 + applicable FF $350,000 + applicable FF $300,000 + applicable FF H Purchase Price in FFPS (Greater of D, E, or (C+F)) $350,000 $360,000 $375,000 I Downpayment in FFPS (H-G) $50,000 $10,000 $75,000 Table 10: Construction Loans – Land was Gifted Lenders should use this table in cases where the land was gifted or inherited by the Veteran free of encumbrance. Item Description Example 1 Example 2 A Cost to Acquire Land n/a n/a B Balance Owed on Land $0 $0 C Contract to Construct + Permits and Reserves (if applicable) $300,000 $300,000 D Acquisition Cost (B+C) $300,000 $300,000 E Reasonable Value (Per NOV) $350,000 $290,000 F Land Value (if given) Not Given Not Given G Max Loan Amount (Lesser of D or E) $300,000 + applicable FF $290,000 + applicable FF H Purchase Price in FFPS (Greater of D or E) $350,000 $300,000 I Downpayment in FFPS (H-G) $50,000 $10,000 138 USC § 3710(a)(1)(3) 238 CFR § 36.4340 338 CFR § 36.4309 438 CFR 36.4302(a) 538 C.F.R. § 36.4313(e)(2) 638 C.F.R. §36.4303(a)(2) 738 CFR § 36.4300(b)(3) 838 USC § 3704(d)(1) 938 CFR § 36.4310(a) 1038 U.S.C. § 3705(a) 1138 CFR 36.4305
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