VA Loans vs. Conventional Loans: All You Need to Know
What You Should Know
- VA loans typically have lower interest rates, but not always.
- VA loans have a 1.4% to 3.6% funding fee, which can be rolled into the mortgage.
- Conventional loans with down payments below 20% have 0.55% to 2.25% PMI costs.
- If interest rates are the same, conventional loans have fewer fees with a 20% down payment.
VA loans are for United States veterans. They offer 0% down payments with some of the lowest interest rates. However, they also come with higher fees than conventional mortgages in some circumstances. If you are a veteran or active duty military member, a VA loan allows buying a primary residence without needing to save up for a down payment.
In contrast, conventional loans may be best if you can find a good interest rate and have a down payment exceeding 20%. If true, you will avoid the VA upfront loan funding fee of 1.4% to 3.6%. However, conventional loans with down payments below 20% require private mortgage insurance (PMI). In this case, the VA funding fee will be similar to the costs of PMI. Continue reading to learn about the two loans and find the best option.
VA vs Conventional Loan Overview
|VA Loans||Conventional Loans|
|Down Payment||0% Minimum|
|Loan Terms/ Structure|
|Additional Fees||Up front 1.4% to 3.6% VA funding fee|
|Personal Requirements||No additional requirements|
*Interest rates taken from our Mortgage Rates Page
VA loans offer some of the lowest interest rates available. This is because the government insures VA loans, protecting lenders from default. Lenders are willing to offer lower rates because they know the government backs the loan.
Although VA loans typically have lower interest rates than conventional mortgages, this isn't always the case. It's important to compare interest rates and find the loan that offers the best value for you. Make sure you are comparing using the annual percentage rate (APR) to see the true cost of borrowing. If you can afford a 20% down payment, conventional loans with a similar or lower interest rate will save you money. This is because VA loans have an upfront funding fee.
The significant benefit of a VA loan is the ability to buy a home without a down payment. However, if you're involved in a bidding war and purchase the property for more than its fair value, you will need to make up for the difference. For example, imagine you purchase a $200,000 home for $220,000. Your VA loan will only lend up to the appraised value, meaning you must contribute the extra $20,000. Additionally, you will still need to consider buyer closing costs.
Conventional loans have two categories of down payments; above and below 20%. With down payments below 20%, you will need private mortgage insurance (PMI). If you make a down payment of 20% or more, you will not be required to have PMI. Therefore, a conventional mortgage may have a lower APR than a VA loan if you make a 20% down payment.
Loan Term and Interest Rate Structure
A VA loan's interest rate structure differs from a conventional loan. VA loans are available in 15 and 30-year terms, while conventional loans typically come in 15, 20, 25, or 30-year terms. With a VA loan, you have the option to finance the upfront funding fee as part of your loan amount or pay it in cash at closing. Additionally, VA loans are not subject to prepayment penalties, while conventional loans typically have penalties if you pay off your loan early.
VA loans come with a funding fee, a percentage of the loan amount paid to the veterans affairs association. The funding fee helps offset the cost of the VA loan program. The funding fee ranges from 1.4% to 3.6% of the loan amount, depending on factors like your down payment and whether you're a veteran or active-duty service member. The funding fee is a one time cost that can be paid upfront or rolled into the loan.
Conventional loans don’t have a funding fee. However, they typically require Private Mortgage Insurance if you make a down payment of less than 20%. The cost of PMI varies, but it can be as high as 2.25% of the loan amount. Keep in mind that PMI charges are an annual fee. Additionally, PMI Down payments above 20% will save you the PMI fee. A conventional loan will save you the VA funding fee if you have enough of a down payment.
Personal Eligibility Requirements
VA loans are available to eligible veterans, active-duty service members, reservists, and surviving spouses. You are eligible for a VA loan if you meet the following criteria:
- 90 days of military service during wartime
- 180 of military service during peacetime
- 6 years of service as a national guard or reserve member
- Spouse of a deceased service member who passed away during service
There are no additional service requirements for a conventional loan. However, you must meet stricter financial standards.
If you don't have a strong credit history or your credit has been damaged, you may still be able to qualify for a VA loan. When determining loan eligibility, the VA considers factors like your employment history, payment history on other debts, and current income.
With a conventional loan, a credit score of 620 is the minimum required to qualify for a loan. If you have a lower credit score, you may still be able to qualify for a loan, but you may need to put down a larger down payment.
Debt-to-income (DTI) Ratio
Your debt-to-income (DTI) ratio is the percentage of your monthly income that goes towards debt payments. This includes your future mortgage payments, alimony, and other debt payments. VA loans allow for more debts with a maximum DTI ratio of 41%. In contrast, most conventional lenders typically want a DTI ratio of 36% or less. However, some lenders are willing to approach a 50% DTI.
Loan to Value (LTV) Ratio
The loan-to-value (LTV) ratio is the percentage of the home's value that you're borrowing. The VA has a maximum LTV ratio of 100%. This means you can finance the entire purchase price of the home.
With a conventional loan, the maximum LTV ratio is 97%. This means you can finance up to 97% of the home's value.
VA loans can be used to purchase almost any type of property, including single-family homes, condos, manufactured homes, and more. There are a few restrictions, such as needing to occupy the home as your primary residence and not being able to use the loan to purchase investment properties.
Conventional loans also have restrictions on what type of property you can purchase. You can use a conventional loan to buy a primary residence, secondary home, or investment property. However, there are strict guidelines for investment properties, and you may be required to put down a larger down payment.
VA loans had a home price limitation until January 1st, 2020. Previously, veterans could not buy homes exceeding around $510,000. This has since been removed.
While conventional mortgages don't have a borrowing limit, your mortgage will have different characteristics depending on the amount. There are conforming loan limits that will affect your type of loan. If your mortgage is below the limit, you will have a conforming mortgage. This means your interest rates will be lower, and you'll have more loan options. If your mortgage is above the limit, you'll have a jumbo mortgage with higher interest rates and down payment requirements.
Frequently Asked Questions
When is a VA loan better?
A VA loan is best for those who want a primary residence with a 0% down payment or can't meet conventional loan financial requirements.
When is a conventional loan better?
A conventional loan is better if you want to buy an investment property or secondary residence. Additionally, if you have a 20% down payment saved, you will save money on fees.
Should those eligible always go with a VA loan?
The main benefits of a VA loan are that you can get a primary residence with 0% down and don't have to pay for private mortgage insurance. Additionally, VA loans typically have lower interest rates than conventional loans. However, buyers with a 20% down payment may save money by choosing a conventional loan if the interest rates are similar.
Is it hard to buy a house with a VA loan? (eg. VA inspections and appraisals)
Some sellers avoid offers to buy a home with a VA loan. This is due to misconceptions over VA loans taking longer to close and a more challenging appraisal process. In reality, VA loans and conventional mortgages have similar appraisal processes. The only difference is that VA loans have minimum property requirements. This includes things such as year-round road access, free of natural hazards, adequate utilities, and more.