The rule is simple: If you’re eligible for a VA loan, it’s likely that this will be your best loan option.
But while this is usually true, there are some unusual circumstances when a conventional mortgage might be the best option. Here are some variables to consider when choosing between a VA loan and a conventional loan.Click here for today's mortgage rates.
Advantages of VA Loans
Many financial professionals will tell you that VA loans are quite simply the best mortgages available to homebuyers. And they’d be right in nearly all circumstances.
Because these mortgages are backed by the U.S. Department of Veterans Affairs. In the case of a foreclosure, the lender will still get some of its money back. This means your mortgage lender assumes less risk and they’ll pass that benefit along to you in a number of ways.
Zero Down Payment
VA loans are available to eligible borrowers with no money down.
Low Mortgage Rates
In January 2021, Ellie Mae found the average mortgage rate for a VA loan that month was 2.60%. That compared with 2.91% for conventional loans.
Of course, mortgage rates will almost certainly have changed by the time you read this (check today’s). But VA loans consistently have lower interest rates than any other type of loan.
Low Minimum Credit Score
Importantly, it’s easier to get approved for a VA loan than a conventional one.
The VA itself doesn’t specify a minimum credit score. Mortgage lenders will set their own credit score requirements. For example, Veterans United typically requires a credit score of at least 660. But all of this means you can probably find a lender that will approve your application if your credit score is 580, though some insist on higher ones.
No Mortgage Insurance
With other loan types, if your down payment is less than 20% of the purchase price of the home you’re buying, you’re nearly always on the hook for mortgage insurance. With government-backed loans (FHA and USDA loans) this mortgage insurance is called MIP (mortgage insurance premiums). With conventional loans, it’s called PMI (private mortgage insurance). Many homeowners find the high monthly premiums, which can be payable for decades, a real burden.
But VA loans have no continuing mortgage insurance. Once you walk away from the closing table, you just have to pay your standard monthly mortgage payments (principal and interest), property taxes and homeowners insurance.
Other VA Loan Benefits
In addition to the four benefits discussed above, VA loans a number of other advantages, including:
- Flexibility. VA loans come in several different flavors including fixed rates and adjustable rates. Additionally, you can borrow over various terms, including 15, 20 and 30 years.
- No prepayment penalties. You can refinance or pay down your loan whenever you want without paying a financial penalty.
- No loan limits. The VA no longer imposes loan limits which means the size of your loan is only dependent on the maximum allowed by your VA lender. That means eligible borrowers can now get a jumbo VA loan under the same guidelines as with a standard VA loan.
- Freedom to comparison shop. The VA guarantees part of your loan but you borrow from a private-sector lender. This means you can comparison shop for the lowest rates and loan costs.
- Low closing costs. The VA caps certain closing costs so you may well find these are lower with a VA loan than for other types of mortgages.
- Streamline refinance option. As long as you don’t wish to take cash out with your refinancing, this refinance loan option means you can go through a quick, cheap and easy process.
Disadvantages of VA Loans
For most Americans, the biggest drawback is that they’re ineligible. You can only get a VA loan with a certificate of eligibility (COE) and they’re available only to those who meet certain service thresholds.
But there are other drawbacks that can sometimes affect those who have COEs. Here are some reasons you might consider a conventional mortgage instead.
VA Funding Fee
The VA funding fee is a lump sum paid on closing, a percentage of the home loan.
If you have a down payment of 0% – 5% of the purchase price and you’re a first-time borrower, you’ll have to pay 2.3% of the loan amount. But that goes up to 3.6% when you use a VA loan more than once.
The VA funding fee is not small, however, it allows the VA home loan program to be self-sustaining. Though it’s not negligible, the fee is what enables the Department of Veterans Affairs to offer zero down payment loans that are unencumbered by mortgage insurance.
You can usually finance the VA funding fee into your mortgage so that it’s incorporated into your monthly payment. Though it’s not a tiny fee, it’s likely to be far less expensive than the mortgage insurance that you would pay on a low down payment conventional or FHA loan.
VA loans are intended to help service members buy homes, not investment properties. You’re expected to occupy the property you purchase with a VA loan as your primary residence. So you can’t use a VA loan to buy a vacation home, rental property or second home.
There are some very limited exceptions to this but the rules are complicated, and you should probably seek advice from a mortgage professional who’s experienced in VA loans.
Stricter DTI Requirements
The other thing that sometimes prevents borrowers from qualifying for a mortgage is their debt-to-income (DTI) ratio. This is the percentage of your gross monthly income that’s eaten up by inescapable commitments, such as housing costs, existing debt payments, alimony, child support and so on. DTI does not include spending on things like food, gas, utilities and similar, which go up and down.
To qualify for a VA loan, your DTI can be as high as 41%.
For once, this requirement is more conservative than for conventional loans, which commonly have a DTI of 45% and, in rare circumstances, as high as 50%.
Strict Property Requirements
The VA is much stricter than most lenders of conventional loans about the quality of the home you can buy. And it has a 52-page rulebook (downloadable as a PDF from its website) that covers everything from attics to zoning.
The VA calls these its Minimum Property Requirements. Any home you buy must either already comply with them or undergo renovation so that it complies by the time you move in.
How do conventional loans compare with VA loans?
Most conventional loans are conforming loans, which means they meet the requirements to be purchased by government entities Freddie Mac or Fannie Mae.
Conventional conforming loans generally:
- Have higher mortgage rates than most other loans, especially VA ones
- Require a minimum down payment of 3%
- Charge no mortgage insurance if your down payment is 20% or higher
- Stop charging mortgage insurance when your equity is 20% or higher
- Require a minimum credit score of 620, though the higher your score the lower your rate will likely be
- Are open to all legal US residents regardless of military service
- Can be used to buy any residential property, including investment and vacation homes
Most Americans with down payments of 20 percent or more find conventional loans are their best choice. Conventional loans do not come with an upfront funding fee, more than making up for the slightly higher mortgage rates.
However, many borrowers with low incomes, lower credit scores and small savings start with a government-backed VA loan to become homeowners. They then switch to a conventional loan when their circumstances improve sufficiently that they qualify for one.
VA Loan vs Conventional Loan: Which is better?
Unless you’re tripped up by the VA’s debt-to-income ratio threshold, funding fee, occupancy requirements or strict property requirements, a VA mortgage loan is likely to be the best option for your home purchase.
Whichever you choose, be sure to get quotes from multiple lenders (the more the better) before committing yourself. As federal regulator the Consumer Financial Protection Bureau says:
“Shopping around for your mortgage has the potential to lead to real savings. It may not sound like much, but saving even a quarter of a point in interest on your mortgage saves you thousands of dollars over the life of your loan.”Click here for today's mortgage rates.