ong both The VA loan is a government-backed home loan designed for veterans and active service members that offers many financial advantages, including no down payment, out-of-pocket costs, or upfront costs. VA loans are among the most cost-effective mortgage programs available to military borrowers. There may be occasions, however, when a VA Loan may not be the ideal choice – in such instances a conventional loan might provide more favorable terms.
Conventional loans are loans not insured by the government that adhere to standards set forth by Fannie Mae and Freddie Mac, both government-sponsored companies that adhere to established lending criteria. Most homebuyers choose this type of mortgage if they can’t qualify for another option or can’t afford a large down payment upfront.
Here is an outline of the differences between VA loans and conventional loans, and when one could be more beneficial.
①Eligibility Criteria
VA Loans:
A key difference between loan types lies in who may apply. Veterans, active military personnel and spouses of deceased service members with a Certificate of Eligibility may apply for VA loans; these aren’t made available to those who do not meet these basic criteria. Most Veterans Affairs loan applicants don’t require any type of down payment to secure financing; when required to make one due to reduced entitlement levels.
Conventional Loans:
Conventional loans do not have specific eligibility requirements; anyone who can meet both financial and credit standards to qualify can take out such a loan.
Conversely, conventional loans require an initial down payment of 5 percent or more (in certain instances, it may even be as little as 3 percent). According to the Federal Reserve Bank’s estimate of the average home costing $503,000 during 2023 Q2, conventional borrowers needing 5 percent would need over $25150 at closing to cover a down payment of this size.
②Debt to Income Ratio
Debt-to-Income Ratio (DTI) can provide an indication of your monthly debt repayment expenses. Lenders use it to assess if you can afford a mortgage on an affordable monthly basis.
VA Loans
The VA allows borrowers to have any DTI ratio, but lenders usually prefer a DTI of no more than 41%.
Conventional Loans
With conventional lenders (VA and conventional), qualifying for a conventional loan may allow a DTI up to 50%. VA loan providers, however, may have lower DTI requirements.
③Credit Score Requirement
VA Loans
VA doesn’t mandate a minimum credit score requirement, though many lenders do have them. Most VA lenders prefer seeing at least 620 for mortgage applications while some will accept even lower scores such as 580.
If your credit score falls within certain parameters, but compensating factors exist such as long-term work history or past home ownership experience, a VA Loan could still be possible for you. A credit advisor could also assist in improving it further.
VA loans allow for the purchase of primary residences only. However, this doesn’t exclude duplexes and fourplexes; nevertheless, to qualify for a VA loan, you must plan for it to become your primary home.
Conventional Loans
Conventional loans may also be used to purchase primary residences as well as vacation homes, rental property and other investment properties.
④Property Restrictions
Both VA and conventional loans can help with the purchase of a primary residence; however, when purchasing additional residential properties (second homes or investment properties) this situation becomes more complex.
VA Loans
VA loans can only be used to purchase a primary home; they cannot be used to acquire secondary or investment properties. VA-backed homes make great secondary or investment properties if you need to relocate but do not intend on selling it.
Conventional Loans
You can use conventional mortgages to finance any of your real estate purchases – whether they are primary homes, secondary properties, or investment properties. Qualification requirements vary depending on the loan product you choose – whether it’s for your primary residence, second homes, or investment properties. When buying a second house or investment property, you must put down at least 10% as an initial deposit, and 15% for second homes and investment properties respectively.
⑤Mortgage Insurance Requirements
Among both loans, VA loans provide more generous terms than conventional mortgages with low down payments due to not requiring mortgage insurance, though they do impose an upfront fee; conventional loans don’t.
VA Loans
VA loans do not require low downpayment borrowers to pay PMI; however, they may still incur a VA financing fee of 1.4% to 3.6% depending on the size and nature of their loan as well as whether this is their first time borrowing through VA.
Pay the fee in cash or add it to your mortgage. Adding it will increase the cost and you will incur interest charges for its duration; additionally, monthly payments may also become higher as a result.
Let’s say you borrow $100,000 over 30 years with a 3% APR and add a 2.3% funding fee of $2300 ($10 a month from $421). Your principal and interest payments would increase accordingly.
Conventional Loans
Conventional loan borrowers who make down payments of less than 20% may need to purchase private mortgage insurance (PMI), similar to how VA funding charges work. Most frequently, borrowers make monthly PMI payments until they reach 20% home equity; once they achieve this threshold, they can cancel PMI.
What’s the Difference between a VA Loan and Conventional Loans?
It depends entirely on an individual’s unique situation and needs. If you lack funds for a down payment or your debt-to-income ratio is high, a VA loan could be your ideal solution. There is an upfront funding fee but no private mortgage insurance premiums to pay each month.
When purchasing your next home or investment property due to VA occupancy restrictions, conventional loans may be the right choice for you. Veterans United can help you achieve your home buying goal. Speak with one of their VA loan experts for an in-depth analysis of your home buying journey.
Final Considerations
If your DTI or down payment funds are limited, a VA loan could be your ideal solution. There is one-time funding fee but no annual mortgage insurance fees to worry about! If you can make at least 20% down payment and waive mortgage insurance premiums, conventional loans could be less expensive than VA loans for purchasing second or investment homes.
Compare mortgage rates and fees between conventional and VA loans. To do this effectively and discuss your options, visit a loan officer who specializes in both types of mortgage loans.
