When making a decision to take out a home loan, choosing between conventional and VA loans appears pretty easy. Zero down payments, mortgage insurance not required, better and more competitive interest rates – the VA home loan wins with no questions, right?
But then, when other things come into consideration, such as the funding fee or perhaps having saved enough money for a down payment so mortgage insurance won’t be needed, the choice becomes trickier. Additionally, the having no credit score requirement or the maximums on the debt-to-income ratio is often overrated.
The following are the dynamics to carefully consider and examine when determining whether to choose a government-backed loan or a traditional one.
To begin, identifying what property type to buy is a great starting point. As Navy Federal Credit Union Assistant Vice President Donna Bradford said, “The VA Loan is for primary residences only. Whereas, conventional loans can be used in purchasing primary or secondary homes. Or even a vacation house. In other cases, one can also purchase rental or investment properties.”
The primary advantage of VA Loans over conventional ones is the zero down payment option. Lenders typically require down payments when a property’s purchase price is higher compared to its up-to-date market value. This happens in housing markets that are highly competitive and with multiple–bidding situations.
Mortgagees offering traditional loans have often preferred higher down payment amounts. But these days, there are financial institutions that allow down payments as low as 3%, sometimes, even less.
Another item to consider is the associated fees. A VA home loan requires the payment of funding fees. This helps defray loan costs that go into default. Although a one–time charge, funding fees are charged upfront and vary from 1.25% to 3.3% of the total loan amount. The percentage differs depending on the down payment amount, branch and length of the borrower’s military service, or whether the borrower has taken advantage of the VA home loan benefit in the past.
In most cases, the funding fee gets added to the total loan amount. As a result, the monthly payment increases. Moreover, it adds up to the interest the debtor pays over the term of the mortgage loan. Veterans receiving compensation under the VA disability benefit, however, are relieved of this requirement. The Department of Veterans Affairs has exempted them.
Private Mortgage Insurance
Conventional loan lenders require borrowers to purchase private mortgage insurance (PMI) if and when the down payment amount is lower than 20%. PMI gives lenders the protection against defaulting loans. This can either be a one–time payment at loan closing, a monthly fee added to the mortgage, or combination of the two.
VA mortgage loans, on the other hand, do not require the purchase of PMI.
“Most VA lenders user credit score benchmarks,” said Bradford. “While minimums vary, they prefer no lower than 620.”
In 2016, the FICO average credit score of closed loans under the VA home loan program was 707, stated Ellie Mae, a mortgage industry software provider. For closed conventional mortgages, the FICO score was 753.
Marketing and promotional materials for most VA loans state there is no maximums when it comes to debt–to–income ratio. However, it also notes that ‘lenders should arrange for compensating factors, including residual income, when the debt ratio is more than 41%’.
Ellie Mae said that for 2016 closed home loans, VA purchase loans had an average debt–to–income ratio of 40% while conventional loans had 34%.
Mortgage interest rates
In 2016, the fixed rate for closed loans with a 30–year term average at 3.76% for VA loans, whereas, conventional mortgages held an average of 3.76%, reported Ellie Mae.
So, which one is best for you: a VA loan or a conventional loan? At the end of the day it’s your choice, just make sure you take into account the pros and cons of each before deciding.