VA, FHA, and conventional mortgages make up 95% of the market, but how do they compare in their requirements and qualifications?
VA is the clear winner here, with no down payment required. Conventional loans require a minimum of 5% down unless you are eligible for either Fannie Mae’s HomeReady or Freddie Mac’s Home Possible programs. These unique programs only require 3% down but are only for low-income buyers. FHA has no income restrictions but requires 3.5% down.
Private mortgage insurance, or PMI, is a policy that protects lenders in case of loan default. These premiums can cost borrowers thousands of dollars at closing and over the life of the loan. VA loans aren’t subject to monthly mortgage insurance premiums. Yet, the Veteran may be subject to a one-time VA funding fee of 3.6% – 1.45%. This fee is not paid out of pocket at closing and is financed into the final loan balance. The VA funding fee % varies based on several factors, including downpayment payment and if it’s the first or subsequent use of the program. Veterans with a disability of 10% or more are exempt from this fee.
Conventional loans without a 20% down payment require PMI. This premium is paid monthly, upfront at closing, or by the lender. Monthly premiums are the most common and are charged until the mortgage balance equals 78% of the property’s original value. The amount of these premiums can vary from individual mortgage insurance companies and may be expensive over time. On a typical mortgage with a 5% down payment, a borrower could expect to pay a premium equal to an extra interest rate charge of .39% to over 1.86%.
FHA borrowers get a double whammy and are subject to two types of mortgage premiums. The first is an upfront mortgage insurance premium. This premium is 1.75% of the loan amount and is financed into the final mortgage balance, the same as the VA’s funding fee. Also, FHA has monthly PMI with premiums equal to an extra interest rate charge of .80% to over 1.05% on a standard 30-year fixed-rate mortgage. Even worse, unless an FHA borrower puts more than 10% down, the monthly mortgage insurance premiums will be charged for the life of the mortgage.
VA and FHA borrowers may see similar rates, .25 – .375% lower than a comparable conventional loan scenario. This is reasonably consistent until a conventional borrower puts 30% down and will have a rate similar to the government-insured mortgage.
VA nor the FHA programs have minimum credit score requirements. Yet most lenders will have some of their own credit score limitations, usually between 580 – 620. Compare this to a conventional loan which has the strictest credit score requirements of 620 or higher.
Yet there is more to the story than just the borrower’s credit scores when it comes to evaluating a borrower’s credit. The VA’s underwriting guidelines for treating derogatory items is much more flexible. These may include collections, judgments, consumer credit counseling, disputed accounts, bankruptcies, foreclosures, and short sales. VA is the clear winner in this category.
Conventional and FHA publish an annual list of all the counties in the US and the maximum loan limits for those counties. If you want to borrow an amount greater than these established limits, then you’ll be forced to consider a Jumbo or non-conforming loan. VA borrowers have the upper hand here as they don’t have any maximum loan limits on a home purchase unless the Veteran has an existing or prior VA loan affecting their entitlement.
The debt-to-income ratio is a key ratio in the mortgage underwriting process. This ratio is calculated by adding the proposed mortgage payment along with the other monthly consumer debt payments and dividing that by their gross monthly income. Conventional loans have a strict 50% maximum debt-to-income rule, whereas VA and FHA do not. Most mortgages today are underwritten using an underwriting program from Fannie Mae and Freddie Mac, known as AUS. With strong enough qualifications, AUS will approve VA and FHA borrowers with over a 50% DTI. Allowing these programs more flexibility than conventional loans.
VA and FHA loans require the buyers to occupy the property as their primary principal residence. With a conventional loan, borrowers can buy a home as a secondary or investment property. However, keep in mind nonowner occupied conventional loans usually require a higher downpayment % and carry higher interest rates.
Assuming someone’s mortgage means you are taking over the financial responsibility of their existing mortgage. This is beneficial when a borrower’s interest rate is much lower than the current market rate. The new borrower can take advantage of the lower payments by assuming the low-rate mortgage.
VA and FHA loans are both assumable, giving them a clear advantage over conventional loans, which are not. But, even though VA loans have this feature, it’s not something we recommend for most Veterans. The problem it creates is with the VA guarantee, which is still tied to the VA mortgage while still outstanding. Until this mortgage is paid off, the Veteran will suffer a partial or full loss of entitlement and may not be able to obtain another VA loan again. Even worse, if the assumed VA mortgage goes into default, the Veteran’s loss of entitlement could be permanent unless the loss is repaid.
The exception to this situation would be an entitlement swap between two veterans. The VA will permit a Veteran to assume another Veterans VA loan and the swap entitlement at the same time. This relinquishes the financial liability and VA guarantee for the Veteran. Allowing them to use the VA loan program again without any ramifications.