A number of unavoidable factors – demographic makeup, inexperience with finances, constant relocation and unemployment among spouses – leave service members more vulnerable to falling into debt than their civilian peers.
The misunderstanding of VA loans demonstrates the financial naiveté of some military members and their families. While it’s believed the VA makes home loans, this isn’t actually the case.
Banks make the loans. The VA guarantees as much as 25% of the loan and puts some restrictions on what banks can charge for loans, but does not decide who gets a loan or how much they get. That is the banks’ responsibility.
Still, the myth persists that a VA loan is made by the VA and it’s just one of many misunderstandings about finances among military members. A 2014 survey by the National Federation for Credit Counseling (NFCC) found that military families had 7% more unsecured debt (about $400-to-$500 on average); about $11,000 less in tangible assets and spent $200 a month more on debt-related expenses than their civilian counterparts.
According to the NFCC, the average military member who contacted a credit counselor had $10,000 in debt and 60% of the service members used payday lenders to help make ends meet.
According to the Department of Defense’s annual Demographic Report for 2014, however, not all the news is bad:
- 87% of respondents used a monthly budget as compared to 34% of U.S. households
- 70% of service members said they checked their credit reports within the last year as opposed to 43% of civilians
- 87% of military families contribute to a retirement account while on the civilian side; 65% have retirement.
- 49% of military families have three months of emergency funds set aside, while only 38% of civilians have enough money to cover emergency room costs or a $500 car repair
It helps that there is a federal law (the Servicemembers Civil Relief Act) that offers a wide range of protections against financial disaster for people on active duty. Among other things, the SCRA caps interest rates on credit cards and mortgages at 6%, prevents lenders from foreclosing on homes and allows military personnel to cancel leases without penalty.
Still, the youth and financial inexperience of many members of the armed services — especially enlisted personnel — make dealing with debt a regrettable part of the experience.
Military Debt Consolidation Loan
When members of the military encounter a financial crisis, or even just hit a temporary wall, there are ways to rally — especially if you have a VA loan on your home.
Having a VA Loan qualifies you for a Military Debt Consolidation Loan (MDCL), also known as a VA Consolidation Loan that can help you overcome financial difficulties. The MDCL operates on the same premise as a regular debt consolidation loan: take out one loan to pay off all unsecured debts, such as credit cards, medical bills, payday loans, etc. and make a single payment to one lender rather than multiple loan repayments to multiple creditors.
The MDCL’s are considered “cash out” loans. That means you are refinancing your current loan for more than the amount owed and taking the difference in cash. There are closing costs involved, which get subtracted from the final amount you receive. For example, if you owed $80,000 on your home, you might qualify for a $100,000 MDCL (depending on the appraised value of your house) and have $20,000 — minus the closing costs — left to pay off credit cards, medical bills or whatever other unsecured debt you have.
The VA is a guarantor for refinancing your loan, but the new loan value can’t exceed the appraised value of your home. Also, there is a limit to how often you take out VA loans if you have trouble repaying them.
The advantage of a Military Debt Consolidation Loan (MDCL) is that you typically pay a lower interest rate and closing costs than civilians and far less interest than you would trying to pay the same bills with credit cards. These refinancing loans can be spread out over 10, 15 — and sometimes even 30 years — giving you a wide-range of repayment choices, depending upon which lender you use.
The obvious drawback to this choice is that you lose the equity in your home, while taking on more debt. There also is the matter of paying closing costs, which vary depending on the lender. Other questions to ask should be whether there is a pre-payment penalty or if there is a balloon payment involved.
Be aware that you must also meet certain qualifications to help ensure that you can and will repay the loan. Lenders will take into account your income and credit score when determining your eligibility. You also need to realize that this process takes unsecured debt like credit card debt and turns it into secured debt. This means your home is acting as collateral and could be taken if you default on your mortgage.
Other Military Consolidation Plans
Depending on the circumstances and amount of debt you owe, there are some other avenues for military members to get relief.
If your problem is confined to credit card debt, another debt consolidation option is to do a balance transfer to another credit card. Several banks and card companies are offering 0% interest on credit cards for as long as 18 months. Most of the offers have a transfer fee, which ranges from 3–5%, but if you pay off your balance in the introductory time period, you still come out way ahead.
Another option is to speak with a nonprofit credit counseling agency to find out if you qualify for a debt management program. You may be able to reduce your interest rates and monthly payment in a debt management program, without taking out an additional loan.
Other choices for debt consolidation – or to avoid foreclosure – would include:
- Special Forbearance – A special forbearance could also be granted if the bank temporarily suspends payments on your mortgage to give you time to avoid foreclosure. Lenders would do this for service members who expect a sudden windfall of cash, either from inheritance, increased pay for combat duty, money from a tax return, etc.
- Repayment Plan – If you have missed a few payments, you could negotiate with the creditor and agree to resume payments with an extra amount added each month until the missed payments are paid off.
- Loan Modification – A VA Loan Modification is when a lender changes the terms of your loan in order to avoid foreclosure. The lender rolls all the delinquent payments into a new balance and begins a new payment schedule.
- Short Sale – The borrower could convince the lender to sell the home for less than what is required to pay off the loan. In a short sale, the lender typically receives some money from the VA to offset the loss.
- Deed in Lieu of Foreclosure – The borrower deeds the property to the lender instead of going through the foreclosure process.
- Postponing Foreclosure – The lender might agree to put off foreclosure to give the borrower more time to sell the home and pay off the loan.
Why Use a VA Military Debt Consolidation?
There are some distinct advantages to being a service member or vet when you are considering a consolidation loan to take care of debt, but there are also some aspects to research and think through before deciding.
Qualifying standards for a MDCL loan are easier than for conventional consolidation loans.
There are some clear advantages, depending on what bank or lending institution you use, including:
- Lower credit score and debt-to-income requirements plus residual income (money left after meeting monthly financial obligations) counts as a positive
- Longer repayment terms
- Up to 100% loan-to-value
- No monthly mortgage insurance premiums or prepayment penalties
Acceptable Closing Costs on VA Loans
One of the overlooked aspects of every loan is closing costs, which often add a significant sum to the total amount being repaid. Banks and lenders dealing in VA loans are restricted by rules on how much they charge for closing costs.
There are two significant rules to consider before closing a VA loan: origination fee cost and VA funding fee.
The VA usually guarantees lenders 25% of the purchase price of a home, in case the borrower defaults. This is known as VA Loan Entitlement. In other words, if a service member or vet buys a $100,000 home and defaults, the VA will guarantee the lender $25,000 toward paying off the remaining balance of the loan.
The money to do that comes from the VA Funding Fee, which is applied to every VA loan or refinance with rates ranging from 1.25% to as much as 3.3%, depending on the circumstances. Some of the factors determining the fee include whether there was a down payment and whether the borrower had a previous VA loan.
Regular military pay slightly lower VA Funding Fees than those in military reserves. Military members with service-connected disabilities can be exempted from the fee.
Origination fees are what lenders charge to cover the cost of processing the loan. The VA limits lenders to charging no more than 1% for origination fees. Origination fees must be paid at closing and aren’t part of your loan. In other words, you have to come out-of-pocket for the 1%.
If the lender charges you an origination fee, they can’t charge you for escrow, mortgage brokers, underwriting or processing fees. Some other fees VA loans don’t allow include termite or pest inspections, realtor fees or loan prepayment fees.
Military Debt Settlement
If you are not a homeowner or are otherwise ineligible for debt consolidation, debt settlement is another option. This is a way of negotiating existing debts in order to reduce the total amount owed. It can be used for any type of debt, including debts owed to the VA.
Like civilians, veterans and active duty personnel can negotiate their privately-held loans such as credit card debt. This is often done with the help of a reputable debt settlement firm, though there is a severe downside to your credit score for choosing this method.
Veterans can also settle debts with veteran-specific credit cards, including the following:
- Chase military credit cards
- Visa Veteran Tickets credit cards
- Navy Federal Credit Union credit cards
- Air Force Federal Credit Union credit cards
- Credit cards granted by Army credit unions
- Auto loans for veterans, including those loaned by the United Services Automobile Association (USAA)
The benefits of credit cards listed above vary, but most carry no annual fee and no fees for balance transfers, cash advances and foreign transactions. The combination of those incentives should add up to substantial savings on your credit card bill and those savings could be applied to debt settlements.
Though you could do this process yourself or hire an attorney, most people begin the process by finding a debt settlement firm to help you negotiate your debts. Choose a reputable firm that does not charge excessive fees. The settlement firm will walk you through the process from there and answer any questions that may arise.
A credit counselor from the firm will speak with you about your financial standing and history, and then help set up a game plan. From there, the counselor will instruct you to set aside a certain amount of money each month, in accordance with the plan you’ve agreed upon.
After you’ve reached a set amount of savings, your counselor will contact your creditors to begin negotiations. The goal of this is to convince your creditors to accept less than the full amount you owe and dismiss the remainder of your debt. Once you complete this transaction, creditors consider your debt to be paid, and you do not owe any more money for that debt.
VA Loan Compromise
If you have a VA debt because of a home loan guaranty, education loan or accidental overpayment of benefits, you might be eligible for a VA Loan Compromise through the Department of Veteran Affairs. This is similar to a settlement but does not require the help of an outside firm.
Request a compromise by submitting a letter to the VA that fully explains your offer and why you are requesting a compromise. Be sure to specify the amount of money you’re offering to settle the loan. Along with your letter, you’ll have to submit a Financial Status Report, VA Form 5655. This is used to determine your ability to pay and whether your offer is reasonable.
Fax all the required paperwork to the VA’s Debt Management Center at (612) 970-5688. If you prefer, you can instead mail your paperwork to the following address:
U.S. Department of Veterans Affairs
Debt Management Center
P.O. Box 11930
St. Paul, MN 55111
If your offer is accepted, you’ll typically have 30 days to make the lump sum payment. Do not send any money until you receive notice that the VA has accepted your offer.
Defaulting on VA Debts
When you can’t pay your VA loans, a compromise is one of the best options available. In some cases, you may be eligible for a debt waiver, which similarly forgives all or part of your debt. Another option is to pay in monthly installments, a technique commonly used by those who are ineligible for compromises but cannot meet their payments.
All of these options are better than the alternative of not paying at all. If the VA notices you have an outstanding debt, it will increase the severity of its reaction over time.
The VA will begin collection attempts by sending you a letter and possibly calling you. If you ignore these contact attempts, the VA will add interest and administrative charges to your balance after 30 days. After 60 days, the VA will begin offsetting any VA payments to you such as your military salary, disability compensation or pension. That means a portion of money will be taken from your check and applied to your outstanding debt.
After 180 days, the VA will contact the U.S. Treasury Department about your outstanding debt. The Treasury can garnish more types of payments to you and is not limited to VA benefits. Payments that may be reduced in order to pay your debt include non-military salaries, Social Security payments and IRS tax refunds.
If these benefits do not apply to you, the VA can either hire a collection agency or sue you in a federal court. This could also be the outcome for privately held debts that go unpaid.
Defaulting on a VA loan will have a dramatic negative impact on your credit score and could keep you from exercising your option to
No matter what kind of debt you have or how tight your budget is, you have various debt reduction strategies at your disposal. Take advantage of these options rather than ignoring the problem.