The VA loan offers qualified borrowers an incredible path to homeownership. However, veterans and active service members often ask if better options exist. Other options do exist – but none better than the VA loan. As such, we’ll use this article to answer the question: why choose a VA loan vs regular mortgage?
Specifically, we’ll discuss the following:
- VA Loan Overview
- Regular Mortgage Overview
- Why Choose a VA Loan vs Regular Mortgage
- Additional VA Loan Considerations
- Final Thoughts
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VA Loan Overview
VA loans serve as the US government’s means for encouraging homeownership among military members and veterans. The program has its roots in World War II. As troops returned from the war, Congress passed legislation – the original GI Bill – that included a mortgage provision. The goal of this program was to create a home loan that would provide an easy path to homeownership for troops.
While the program has changed over the years, the VA loan still provides eligible borrowers an outstanding path to homeownership. The Department of Veterans Affairs now administers the program, and the VA loan offers the following tremendous terms:
- No down payment required
- No private mortgage insurance (PMI) required
- Low interest rates
- Streamlined refinancing option via the Interest Rate Reduction Refinance Loan (IRRRL)
Regular Mortgage Overview
When service members ask about “regular” mortgages, they typically want to know about two types of non-VA loans: FHA loans and conventional mortgages. We’ll briefly explain both of these here, and the remainder of the article will explain the advantages VA loans have over both options.
FHA Loan
Similar to the VA loan, the Federal Housing Administration, or FHA loan is a government-backed mortgage designed to encourage homeownership. In particular, the program aims to provide a low-cost mortgage option to low-to-moderate-income borrowers. But, despite this goal, no income ceiling exists for the program.
With FHA loans, borrowers can qualify for a loan with as little as a 3.5% down payment. Additionally, the program allows borrowers to receive that down payment in the form of savings, a financial gift from family members, or a down-payment-assistance grant. These outstanding terms generally make FHA loans the mortgage of choice for non-VA borrowers.
Conventional Mortgage
Whereas VA and FHA loans are specific loan products, conventional mortgage serves as more of an umbrella term. More precisely, the term conventional mortgage refers to home loans not backed by a government entity. Instead, banks and other mortgage lenders issue these loans based solely on their own lending criteria.
In general, lenders require down payments of at least 20% on a conventional mortgage. However, some lenders will approve loans with as low as 5% down, depending on the borrower’s overall financial situation.
Why Choose a VA Loan vs Regular Mortgage
No Down Payment Required
Down payments tend to be the largest obstacle buyers face when trying to purchase a home. Accordingly, the fact that the VA loan doesn’t require one makes it an incredible mortgage option, potentially saving buyers thousands of dollars in out-of-pocket costs.
For example, say you want to buy a home for $300,000. With a VA loan, you would have a $0 down payment (though you would still need to pay loan closing costs). On the other hand, this same loan would require a $10,500 down payment for an FHA loan ($300,000 x 3.5%) and a minimum of $15,000 for a conventional mortgage ($300,000 x 5%).
No PMI/MIP Required
When lenders accept less than a 20% down payment, they view the mortgage as riskier. To offset this risk, both FHA loans and conventional loans with less than 20% down payments require a form of insurance. Basically, borrowers pay insurance premiums to offset the increased risk of default due to the smaller down payments.
With FHA loans, borrowers must pay the program’s Mortgage Insurance Premium (MIP). This includes a one-time premium and a recurring, annual one. Similarly, conventional mortgages with less than 20% down mandate private mortgage insurance (PMI) until borrowers reach at least 20% equity in the home. While MIP and PMI are different programs, they function similarly. And, both can add thousands of dollars in costs to a borrower over the life of a loan.
VA loans do not require PMI or MIP.
Lower Annual Percentage Rates (APR)
When a lender promotes a mortgage interest rate, think of that as face value. On the other hand, once all of the fees, points, and other loan-related charges have been factored in, the cost of borrowing is known as APR. As a result, APR more accurately reflects the cost of a loan over its life.
Generally speaking, VA loans offer lower APRs than both FHA loans and conventional mortgages.
Streamlined Refinance Opportunity via IRRRL
The VA offers a streamlined way to refinance your current VA loan. Known as the Interest Rate Reduction Refinance Loan, this program allows borrowers to quickly and easily take advantage of lower interest rates.
With a normal refinance, you essentially apply for another mortgage. This means full income verification and the administrative hassle of applying for a loan. The VA’s IRRRL does not require income verification, making it an extremely easy refinance process for borrowers. The program was designed to make it as easy as possible for VA loan borrowers to save money when interest rates fall.
No Maximum DTI or Minimum Credit Score
With the VA loan, the VA doesn’t actually lend money. Instead, it guarantees the loans of a variety of VA-insured lenders (e.g. banks, credit unions, and mortgage lenders). In doing so, the VA provides lending guidelines, but borrowers must meet the approval criteria of their respective lenders. Of note, the VA’s program guidelines do not require a maximum debt-to-income (DTI) ratio or minimum credit score to qualify for a VA loan. This gives lenders more flexibility to approve a borrower based on his or her overall financial situation – and ability to repay the loan.
Conversely, both FHA loans and conventional mortgages typically cap DTIs at 43%. And, they also impose minimum credit scores, with most conventional loans requiring at least a 620, while FHA loans require a 580 minimum score (though exceptions exist). These requirements typically reduce the flexibility of lenders to approve FHA loans or conventional mortgages.
Additional VA Loan Considerations
For the above reasons, the VA loan generally makes far more sense than a regular mortgage. But, borrowers should still consider the following characteristics of a VA loan before making a final decision.
VA Funding Fee
While the VA loan doesn’t require PMI or MIP, it does require a VA funding fee. The VA uses this fee to offset the costs of the loan program to taxpayers. And, depending on the specific loan, this fee ranges from 1.4% to 3.6% of the total loan amount, with borrowers able to either pay up front or roll the fee into the loan principal.
However, 1) veterans with a service-connected disability, and 2) Purple Heart recipients do not need to pay the VA funding fee.
Occupancy Requirements
The VA loan exists to promote homeownership – not investing. As a result, the VA imposes an occupancy requirement. Borrowers must occupy the purchased property as their primary residence within 60 days of closing, and they must live there for up to a year.
FHA loans impose similar restrictions, but conventional mortgages can be used for pure investment property purchases. But, these investment property loans generally come with larger down payment requirements and higher interest rates.
However, for VA loan borrowers looking to rent out a property, a loophole exists. The VA loan allows borrowers to purchase up to a fourplex. And, so long as they occupy one of the units as their primary residence, they can rent out the other three.
VA Appraisal and MPRs
To support the program’s homeownership objective, the VA requires that all purchased properties are safe, sound, and sanitary. Simply put, a home must be habitable, with borrowers able to move in immediately. To enforce this, the VA has created property standards known as Minimum Property Requirements, or MPRs. When a VA-approved appraiser conducts the home appraisal, he or she will highlight any MPR issues in the final report. When VA reviewers see these issues, they will not approve the loan until the problems have been resolved.
While this can be an issue for a buyer, MPRs actually provide VA loan users negotiating leverage. If a seller wants to close a deal, he or she will need to work with you to resolve all MPR issues before closing, meaning you won’t need to once you move into the home.
Final Thoughts
Unless you want to buy a property strictly for investment purposes, VA loans are the best mortgage option for eligible borrowers. While regular mortgages have some advantages, VA loans simply offer more benefits to people looking to buy a primary residence.
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.
