When buying houses, veterans typically use the VA home loan. However, depending on their unique circumstances, the FHA loan can be another great option for veterans. As such, we’ll use this article to cover the benefits of FHA loans for veterans.
Specifically, we’ll discuss the following:
- FHA Loan Overview
- Benefits of FHA Loans for Veterans
- Disadvantages of FHA Loans for Veterans
- When Veterans Should Use the FHA Loan
- Final Thoughts
FHA Loan Overview
The Federal Housing Administration, or FHA, created the FHA loan program to encourage home ownership among Americans. The loan program began in 1934, and it offers low- to moderate-income homebuyers an opportunity to secure mortgages. But, no income ceiling exists, meaning you won’t be disqualified from an FHA loan for making too much money.
Similar to the VA loan, the FHA does not actually issue loans. Rather, it insures the loans of FHA-approved lenders throughout the country (e.g. banks, credit unions, and mortgage companies). This insurance protects lenders in case of borrower default. If the borrower stops repaying a loan, the FHA will step in and reimburse the lender for the outstanding loan balance. This reduces risk for lenders. And, this lower risk allows lenders to provide the following outstanding terms with FHA loans:
- Low down payment requirements
- Allowable seller concessions
- Low credit score requirements
Of note, this FHA program exists to support homeownership – not real estate investing. FHA loan borrowers need to actually occupy their properties as a primary residence for a year after closing.
Benefits of FHA Loans for Veterans
While it’s hard to beat the advantages of VA loans, veterans in some circumstances may want to consider using an FHA loan. As a result, it’s important to understand the major benefits FHA loans provide to veterans. In this section, we’ll discuss some of these major benefits.
Low Down Payments
FHA loans require a minimum down payment of 3.5%. While this is greater than the zero-down requirements of VA loans, it offers savings relative to conventional mortgage loans. Conventional loans are ones not backed by the federal government. And, they require a minimum down payment of 5%.
For example, assume a veteran wants to purchase a $300,000 home. With an FHA loan, this will require a down payment of $10,500 ($300,000 x 3.5%). On the other hand, a conventional loan on the same property requires a minimum down payment of $15,000 ($300,000 x 5%). This means the veterans would need to bring $4,500 less in cash to the closing with an FHA loan.
Low Credit Score Requirements
While rare, FHA guidelines allow borrowers with credit scores as low as 500 to qualify for financing. However, scores this low typically require larger down payments to offset the increased risk of borrower default.
Individual lenders will set their own credit requirements. But, in general, lenders will require minimum FICO credit scores of 580 to qualify for an FHA loan. On the other hand, conventional mortgages tend to have stricter credit requirements, with most lenders setting 620 as a minimum qualifying score. For veterans with poor credit, this means that an FHA loan may be an option if they fail to meet conventional loan requirements.
Seller Concessions
Both FHA loans and conventional loans allow sellers to cover a portion of a buyer’s closing costs. And, most first-time homebuyers don’t realize how quickly these costs can add up. Closing costs include all the non-down payment costs borrowers need to pay at closing (e.g. loan origination fees, transfer taxes, prepaid items, etc.). And, while closing costs will vary by deal, they average between 2% and 5% of the loan amount. This means that buyers potentially need to bring thousands of dollars to closing – above their down payment.
Unfortunately, conventional loans with down payments less than 10% cap seller closing cost contributions (known as seller concessions) at 3% of the purchase price. On the other hand, FHA loans let sellers contribute up to 6% of the purchase price. This 3% difference means that veterans using an FHA loan could potentially save thousands of dollars in closing costs by using an FHA loan instead of a conventional one.
No Funding Fee
With a VA loan, most veterans need to pay a funding fee to use the loan. This fee helps offset the costs of the program for taxpayers. With an FHA loan, veterans do not need to pay a funding fee. However, as we’ll discuss below, these loans require other loan-related costs.
No First-Time Homebuyer Requirement
While FHA loans exist to foster homeownership, you don’t need to be a first-time homebuyer to use them. This provides veterans a key advantage. In the military, service members typically move multiple times and often purchase homes at each new duty station. As a result, FHA loans offer tremendous flexibility. Regardless of previous home purchases, veterans can still qualify for an FHA loan. But, they must still meet the above occupancy requirements of the loan program.
Disadvantages of FHA Loans for Veterans
For most homebuyers, there really aren’t any disadvantages to using FHA loans. Simply put, it’s an outstanding loan program. However, when compared to the VA loan, veterans should understand the following major disadvantages.
Mortgage Insurance Premium
While FHA loans may not require a funding fee, they do require FHA-specific mortgage insurance. Known as the mortgage insurance premium, or MIP, this insurance includes two parts. First, buyers need to pay an up-front amount. This up-front amount is 1.75% of the loan amount. But, buyers don’t pay this at closing. Rather, lenders roll it into the total loan balance, and borrowers pay it off over the life of the loan.
Next, borrowers need to pay an annual MIP amount. The amount is assessed as a percentage of the outstanding loan and varies based on A) the size of the down payment, and B) the length of the loan. While assessed annually, most lenders divide this amount by 12 and add it onto a borrower’s monthly mortgage payment.
Down Payment
As stated, veterans face lower down payment requirements with FHA loans than conventional loans. But, relative to VA loans, veterans would need to pay far larger down payments with FHA loans. Continuing the above example, a veteran using a VA loan instead of an FHA loan to purchase a $300,000 home would not need to bring that $10,500 ($300,000 x 3.5%) down payment to closing. Of note, veterans would still need to pay this $10,500, but they would do so over the life of the loan.
Loan Limits
Individual VA lenders will likely impose ceilings on how much veterans can borrow with a VA loan. But, the VA loan program no longer sets a maximum loan amount. On the other hand, the FHA does limit the size of the loan you can borrow. While the FHA adjusts this ceiling based on geographic cost-of-living considerations, veterans still could find themselves in a situation where they couldn’t buy a particular home with an FHA loan due to these limits.
When Veterans Should Use the FHA Loan
After reviewing the above benefits and drawbacks to FHA loans, the question remains: as a veteran, when should I use the FHA loan? Broadly speaking, four scenarios exist when it may make sense for a veteran to use an FHA loan over the VA loan.
Scenario 1: Saving VA Loan Eligibility for an Uncertain Future
Uncertainty and military service go hand-in-hand. As service members, we often don’t know where the military will send us next. Similarly, many veterans face uncertainty upon separating. They may go back to school, jump between their first few civilian jobs, or just generally move around without a clear vision. For these reasons, many veterans choose to save their VA loan eligibility for an uncertain future.
For example, if veterans attend school immediately upon separating, they may want to purchase a home. However, if they may move after school, using an FHA loan during school and saving the VA loan until settled with a permanent home down the line may make sense.
Scenario 2: Already Used Your VA Loan Eligibility and One-time Restoration
Some veterans need to use FHA loans because they’ve already used their VA loan eligibility. While exceptions exist, veterans can generally use the VA loan once then apply for a one-time restoration of eligibility to use it again. As a result, some veterans may no longer qualify for a VA loan. In this situation, an FHA loan serves as a great alternative. Veterans may not receive zero-down benefits, but they also don’t need to meet conventional mortgage down payment requirements.
Scenario 3: Don’t Qualify for the VA Loan Due to Military Service
Other veterans may have never qualified for the VA loan. To receive VA loan eligibility, veterans must A) meet minimum service requirements, and B) not have received an other-than-honorable, bad conduct, or dishonorable discharge. Accordingly, if veterans never qualified for VA loans, FHA loans represent great alternative mortgage options.
Scenario 4: Cost-of-living Strategy
Veterans may choose to use an FHA loan over a VA loan due to cost-of-living considerations, as well. For instance, assume a veteran lives in a lower cost-of-living area for a final tour, then plans on moving to a higher cost-of-living area after completing military service. If he or she wanted to buy homes in both areas, it would make more sense to use the FHA loan in the lower-priced area and save the VA loan for the higher-priced one.
Let’s say the average home price in one area is $250,000 and $400,000 in the other. With the VA loan, you don’t need to pay any down payment. With the FHA loan, you need to pay 3.5%. As such, the veteran may look at this situation through the lens of smaller down payment requirements. In other words, do I want to pay a $14,000 down payment ($400,000 x 3.5%) or an $8,750 ($250,000 x 3.5%) one? By saving the VA loan for the more expensive area, this veteran would minimize his or her out-of-pocket down payment requirements for the two home purchases.
Final Thoughts
In most scenarios, the VA loan makes more sense for veterans than the FHA loan. However, tremendous benefits exist with FHA loans, too – especially when compared to conventional mortgages. Veterans should understand these FHA loan benefits, as they may encounter situations where using one of these loans makes sense.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.
