VA Loan vs Conventional Loan

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Overview

While many in the military community take advantage of their lifetime Veterans Administration (VA) loan benefit, you may wonder why anyone who qualifies would consider a conventional home loan. A VA home loan has less restrictive credit requirements yet slightly stricter property requirements than a conventional mortgage or an FHA loan. There are some instances when the flexibility of a conventional loan may be more suitable. A VA loan can come with caveats that may make the comparison, VA loan vs conventional loan, more complex to weigh.

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Products Compared

VA vs Conventional Loan

Topics Ahead

I. Interest Rate
II. Mortgage Insurance (PMI)
III. VA Funding Fee
IV.Appraisals
V. Bankruptcy
VI. Entitlement, Loan Limits
VII. Down Payment
VIII. Property Requirements
IX. Refinance
X. Debt-to-Income (DTI)
XI. In Closing

Provided for informational purposes only and subject to change. These represent common eligibility requirements across the industry for conventional and VA loans. Strong Home Mortgage eligibility requirements may differ. Contact a loan officer to discuss.

I. Interest Rate

An interest rate is what you pay each year to borrow money. Typically, interest rates for VA loans are lower compared to conventional loans. However, there are some scenarios where a lower rate can be obtained using a conventional mortgage. Let’s take a closer look at interest rates, VA vs conventional loan.

Variables

Interest rates do not reflect any costs associated with the loan. The annual percentage rate (APR) for a VA or conventional loan reflects a broader borrowing cost and includes additional fees associated with obtaining the loan. These fees may include private mortgage insurance (PMI) costs. Unless exempt, a VA home loan will have a one-time upfront funding fee tied to the loan, while a conventional loan may have PMI where the down payment is less than 20%.

Bottom Line

It’s essential to compare the APR, which factors in other costs associated with the loan. This includes the VA’s funding fee which varies based on several factors including whether you’ve used a VA home loan in the past. Your credit score and size of down payment will also affect your interest rate. Of course, rates are also affected by market conditions.

II. Mortgage Insurance (PMI)

Private Mortgage Insurance (PMI) is designed to protect the lender if the borrower defaults on a loan. While the VA loans don’t require PMI, it will likely be required on a conventional loan if the down payment is below 20%.

Variables

PMI rates vary based on factors including your credit score and loan-to-value (LTV) ratio, which is the loan amount compared to the appraised value of the home. PMI is usually paid as a monthly fee. However, you may opt to pay it as an upfront fee or take a slightly higher interest rate to cover the PMI.

When home values increase significantly, you should inquire with your loan servicer to see if you’re eligible to remove PMI earlier from a conventional mortgage. Once you hit 22% equity, PMI automatically drops off unless it is a second home or investment property. For those property types, the PMI may remain in place for the entire loan. There are other loan scenarios that may be pursued which do not carry PMI and allow an out-of-pocket down payment less than 20%. Contact a loan officer to learn more.

Bottom Line

While the VA doesn’t require PMI, they require a funding fee, which varies depending on several factors. This is a key distinction, VA vs conventional loan.

III. VA Funding Fee

The VA funding fee is a one-time expense with a VA loan. It assists with funding the VA loan program so that VA loans can include features such as no down payment or private mortgage insurance.

Variables

VA’s funding fee varies depending on several factors including veteran designation, the amount of the down payment, loan type, and whether you have received a VA loan in the past. Be sure to compare VA’s funding fee to fees you would pay on a conventional mortgage.

The VA funding fee may be waived in certain circumstances involving veterans that are eligible to receive compensation for service-related medical conditions and injuries. The funding fee may also be waived for those who’ve earned a purple heart or have disabilities due to their time in military service. Other exemptions to the funding fee may apply, contact a loan officer to learn more.

Bottom Line

A funding fee may be required on VA home loans, but you will not be required to pay PMI if the down payment is less than 20% as would likely be required for a conventional loan. It’s essential to compare the APR for both loan types. Depending on your upfront rate for VA’s funding fee, the comparison could level off, VA vs conventional loan. The options may become equally appealing, especially if you have a high credit score and can put down a 20% down payment.

IV. Appraisals

VA loan appraisals must be performed by a VA-approved appraiser. The appraisal must highlight any issues that render a property unsafe, unsound, or unsanitary for occupancy. The seller must address any of these issues before closing. Conventional loans may have less stringent requirements which may allow for “fixer uppers.”

Variables

Appraisal requirements vary by lender for conventional loans. Requirements for VA loans are likely to be the same across all lenders.

Bottom Line

Conventional loans may have fewer requirements for appraisals. The VA has made recent changes to expedite the appraisal process and make more VA-approved appraisers available in competitive markets. Both options, VA vs conventional loan, make appraisals easier.

V. Bankruptcy

You may be eligible for a conventional mortgage four years from the dismissal date on a Chapter 7 bankruptcy. For a Chapter 13 Bankruptcy, when you become eligible for a conventional loan depends on how the case proceeds. If the court dismisses a bankruptcy, typically a four-year waiting period is required. If the case is discharged, it is typically a four-year waiting period from the filing date and two years from the dismissal date.

Those with bankruptcy can bounce back even quicker when it comes to VA loans. You may be eligible for a VA loan just two years after a dismissal date for chapter 7 bankruptcy and one year after filing a Chapter 13 bankruptcy. This is yet another key difference between VA and conventional loans. 

VI. Entitlement, Loan Limits

The VA home loan limit refers to the maximum loan amount the VA will insure and not the limit how much you may borrow from your lender. These loan limits differ depending on whether you’re eligible for your full or remaining entitlement. With full entitlement, there is no loan limit on the amount that the government will insure your loan.

Conventional loans that Fannie Mae and Freddie Mac back must not exceed $647,200 (2022). In many parts of the country, this limit may be higher. For instance, Fannie and Freddie allow a loan amount up to $970,800 in certain state counties. Loans exceeding the limits of Fannie and Freddie are considered non-conforming and may qualify under a Jumbo mortgage, which is designed to finance homes above these limitations.

Variables

You may have a remaining entitlement, referred to as “Partial Entitlement,” in which case the VA home loan limit is based on the county loan limit. This limit is generally the same as the loan limit as on a one-unit conforming conventional loan limit.

Bottom Line

The rules regarding maximum loan amounts can be complex, but the key takeaway is that there may be limitations with each, VA vs conventional loan.

VII. Down Payment

Conventional loan borrowers typically make a down payment of anywhere between 3% and 20%. If the down payment is below 20%, then lenders likely require private mortgage insurance (PMI). VA loan borrowers may be able to put as little as zero down with no required private mortgage insurance. However, Keep in mind that VA may require an initial VA funding fee.

Variables

If you can afford to place 20% down, and you want immediate equity in your home, then making a higher down payment may be the best option. It means a lower monthly payment as well as fewer interest payments over the life of the loan.

A zero down payment increases your risk for negative equity. Should the market suddenly take a downturn, then you might need to sell your home sooner than expected.

Even if you have the means for a 20% down payment, you may want to use the funds for something else.

Bottom Line

VA loans allow you to get into a home quickly because there may be no down payment required unless the purchase price exceeds the reasonable value of the property. However, if you have the funds to put down a 20% down payment, then the zero down payment option for a VA loan may not be a deciding factor. Determine what you can and are willing to afford upfront. That could simplify how you feel overall about each of these product offerings, VA vs conventional loan.

VIII. Property Requirements

Generally, a VA loan requires that the property be used as a primary residence. You can’t use a VA loan to purchase a second home, investment property, or vacation home. On the other hand, conventional loans allow for all these property types.

Variables

Under a VA loan, you may rent your home only if you’ve occupied the home as your primary residence for a year.

Bottom Line

Property usage requirements are certainly different, VA vs conventional loan. Conventional loans offer more flexibility. Conventional loans are also an excellent tool for investors looking to build wealth through a portfolio of rental properties.

IX. Refinance

A VA loan offers a cash-out refinancing option up to 100% of your home’s value. On the other hand, conforming conventional loans backed by Fannie and Freddie typically limit cash-out to 80% of your home’s value.

Variables

There are several considerations as you evaluate refinancing, VA vs conventional loan:

  • What’s your refinancing goal? If you’re looking for a cash-out refi, a VA loan may be appropriate if you wish to take out substantial equity.
  • What’s your current mortgage? If you currently have a VA home loan, then a VA Streamline Refinance may be your best option.

These are but a few questions to ask. Your loan officer can guide you through any others that arise.

Bottom Line

The VA Streamline Refi is a unique program designed only for those borrowers who already have a VA loan on their home. It provides a quick and easy way for you to obtain a mortgage at a low rate. The benefits of a streamline refinance include minimal paperwork, an appraisal waiver, and no need to verify income or credit.

X. Debt-to-Income (DTI) Ratio

VA and conventional loans may have different requirements for DTI ratios. Acceptable DTI ratios for each loan type vary based on other factors including additional cash reserves that a borrower may have.

Variables

DTI requirements vary for both loan types depending on several factors including down payment, credit score, and cash reserves.

Bottom Line

Consult with a loan officer to determine the DTI requirements based on your individual situation. then determine which loan type is right for you, VA vs conventional loan.

XI. In Closing

If you qualify for a VA home loan, and have ample funds for a down payment to avoid PMI, and seek a second home or investment rental, then you might appreciate the flexibility of a conventional mortgage. This may be a surprising finding, which is why we compared VA vs conventional loan at great length here — so you can decide which path is right for you.

Ready to explore your options, VA vs. Conventional loan?

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