Comparing a VA Loan to a Conventional Mortgage

When purchasing a home, one must decide on what type of loan one is going to use.   It seems that choosing between a VA loan or a conventional loan would lean heavily towards a VA loan.   After all, with the VA loan, one does not need to put any money down and there is no mortgage insurance.  

The decision is a little bit more difficult than that.  The reason is that the VA funding fee adds an additional cost to the borrower.   Moreover, a borrower can avoid the cost of mortgage insurance, by putting 20 percent down on a property using a conventional loan.  There are other factors as well, including the minimum credit score and the maximum debt-to-income ratio for the borrower. 

Here are the factors to consider when deciding between a Department of Veterans Affairs mortgage and a conventional loan.

Loan Requirement	VA Loan	Conventional Loan
Property	Primary Home	Primary or second homes; Investment properties
Minimum Down Payment	None	As low as 3%
Fees	VA Loan Funding Fee	Varies by lender, but usually an origination fee is charged
Mortgage Insurance	None	Required if down payment is less than 20%
Minimum Credit Score	Varies by lender	620 FICO Score

Property type

With a VA loan, the property must be used as a primary residence.   It can not be used for investment purposes.   A conventional loan can not only be used to purchase a primary residence, but it can also be used to purchase a vacation home or a rental property.

Down Payment

The VA loan requires no money down when purchasing a property.   The only instance in which a borrower may be required to pay money is when the value of the property is less than the appraisal amount.  It usually occurs in instances where there are multiple bids on the property or in a seller’s market in which the listing price is greater than the market value.

Some conventional loans require that the borrower pay as little as 3.5% towards the purchase price on the property.   Lenders, however, usually require larger down payments.

Fees

The VA loan usually charges a funding fee.  Borrowers will pay a funding fee ranging from 1.4% to 3.6% of the loan amount for the purchase since it helps to lower the cost of the loan for U.S. taxpayers.   The fee amount varies based on your down payment amount and whether this is a borrower’s first VA loan.  The fee is normally rolled into the loan and can increase the payment that a borrower is paying on the note.

It should be noted that veterans that have been determined by the VA to have a service-connected disability are exempt from paying the funding fee.   

Mortgage Insurance

Under the VA loan program, one of the benefits to a borrower is that there is no need for mortgage insurance. 

With a conventional loan, if a borrower puts down less than twenty percent of the purchase of the property, then they are required to pay for mortgage insurance.   There are some exceptions to that and some lenders are willing to forego mortgage insurance if the borrower pays down as little as 5.0%.  The fee can be tacked onto the mortgage or it can be paid down at origination or a combination of the two.  The amount that one pays for PMI will vary by the lender.

Credit Score Standards

There are rumors that credit scores do not matter when a borrower is considering the VA loan.  But, there are professionals that admit that the credit score serves as a benchmark when considering the VA loan.  Usually, the benchmark score that lenders consider are 630 or higher.

With a conventional loan, the score is usually 753 or higher. 

One alternative to a person that has low credit scores is to consider an FHA loan.

Debt-to-income Ratio

The maximum debt-to-income ratio on a VA loan is usually 41%.  If it exceeds 41%, then the lender will consider compensating factors including residual income.  This is the amount of money left over after living expenses and the mortgage have been paid. 

Mortgage Rates

This is another advantage of the VA loan.  Typically interest rates are lower for VA loans than they are for conventional loans.  The reason is that the loan is backed and guaranteed by the Department of Veteran Affairs, whereas a conventional loan requires that the lender assume all the risk.

These are all the factors to consider when one is going to purchase a home or a rental property. The decision is not easy, but hopefully these guidelines will help one with their decision.