Are you torn between a VA loan and a conventional loan? Both have benefits that make them attractive, but VA loans take the cake in most instances. They also help make homeownership more accessible and affordable for those who’ve served in the armed forces.
Read on to learn more about the specifics of VA loans and conventional loans, how they differ, and the pros and cons to consider when deciding which is right for you.
Comparing VA Loans and Conventional Loans
VA and conventional loans can be used to purchase or refinance a home. Here’s an overview of each type of mortgage product.
What is a VA Loan?
Backed by the U.S. Department of Veterans Affairs, VA loans are exclusive to active-duty service members, veterans and qualifying spouses. These home loan products are accessible through VA-approved lenders and come with several perks that make them an attractive option, including competitive rates, flexible credit guidelines, and no down payment or private mortgage insurance (PMI) requirements. More on these benefits shortly.
What is a Conventional Loan?
Conventional loans are traditional mortgages offered by private lenders, including banks, credit unions and online mortgage loan originators. You can get a good deal if you have a strong credit score and meet the other lending guidelines, but you won’t find as much flexibility with these loan products. Furthermore, they generally require a down payment and private mortgage insurance (PMI) if you put less than 20% down.
VA Loan vs Conventional Loan: Key Differences
Below are some key differences between the two loan products to be aware of.
Purpose
- VA loans: VA loans exist to help active-duty service members, veterans and qualifying spouses access affordable home purchase, construction, and refinance opportunities.
- Conventional loans: Conventional loans are accessible to anyone who meets the program guidelines and can also be used to buy, build or refinance a home.
Eligibility Requirements and Qualification
- VA loans: You must meet the VA’s minimum service requirements and obtain a Certificate of Eligibility (COE) to be considered for a VA loan.
- Conventional loans: Again, conventional loans are open to anyone with a credit score of at least 620 that meets the income and debt-to-income (DTI) ratio guidelines. The latter should be lower than 41% for the best approval odds. Lenders often implement overlays, or more stringent lending criteria, that you must adhere to for loan qualification.
Down Payment Requirements
- VA loans: The primary draw of VA loans is the ability to secure 100% financing, which means you won’t need a down payment to get approved for a mortgage.
- Conventional loans: You’ll need a down payment between 3% and 20% of the home’s purchase price to qualify for a conventional loan.
Interest Rates
- VA loans: VA loans typically come with lower interest rates compared to conventional loans since they are government-backed and less risky to the lender.
- Conventional loans: The most competitive rates on conventional loans are typically reserved for borrowers with strong credit scores.
Private Mortgage Insurance (PMI)
- VA loans: You won’t pay PMI on a VA loan, even if you don’t put money down, which saves you a bundle over the loan term.
- Conventional loans: If you put less than 20% down, you’ll generally need to pay PMI until you reach at least 20% in equity.
Loan Limits
- VA loans: There are no loan limits for borrowers with full entitlement, and the VA guarantees 25% of the loan amount if you default and your loan exceeds$144,000. However, taking out a loan that exceeds the conforming loan limit could mean a down payment is required.
- Conventional loans: These loans are capped at the limits set by the Federal Housing Finance Agency (FHFA) and conform to both Freddie Mae and Fannie Mac standards.
Fees and Closing Costs
- VA loans: You’ll pay a mandatory funding fee unless you qualify for an exemption. The amount depends on your down payment and how often you’ve used the VA loan benefit. VA loans also have caps on certain closing costs.
- Conventional loans: There’s no specific funding fee with conventional loans, but expect to pay closing costs between 3% and 5% of the loan amount.
Property Requirements
- VA loans: VA loans can only be used to buy or refinance a home used as your primary residence, and the property must meet the VA’s Minimum Property Requirements (MPRs).
- Conventional loans: You can use a conventional loan to buy or refinance a primary residence, second home or investment property.
Pros and Cons of VA Loans
There’s a lot to love about VA loans and potential disadvantages to be aware of. Here’s a more in-depth look at the pros and cons of each.
Pros
- There is no down payment requirement: The ability to buy a home with 100% financing is a major perk, as it helps make homeownership more accessible. And you could use the funds you’d otherwise save for a down payment to meet important financial goals.
- No private mortgage insurance (PMI): Steering clear of this added cost gives you lower monthly mortgage payments. You could also get more buying power by avoiding PMI.
- Competitive interest rates: A lower interest rate means considerable cost savings over the loan term. And you’ll see a difference in the monthly mortgage payments, too.
- Flexible credit guidelines: If you have a lower credit score, you could have better luck with a VA loan. Although most lenders require a score of at least 620, there’s no preset minimum from the VA, and you could get approved with a lower credit rating.
Cons
- Must use a VA-approved lender: You can access a VA home loan unless you work with a VA-approved lender. If you already have a lender in mind, but they don’t fit into this category, you’ll need to explore other options.
- VA funding fee: This one-time payment is required by the VA unless you qualify for a waiver. The upside is you can roll it into your loan amount, although doing so will increase your borrowing costs.
- Only available for use with primary residence: You can only use VA loans to purchase, construct or refinance a primary residence. This can be a significant downside if you are planning to buy an investment property or vacation home.
Pros and Cons of Conventional Loans
Like VA loans, conventional loans have their share of benefits and drawbacks.
Pros
- Flexible use: Conventional loans can be used for primary residences, second homes and investment properties. This makes this mortgage a versatile option, whether you’re looking for a home to live in or a rental property.
- PMI cancellation: Conventional loans require PMI with a down payment of less than 20%. However, it can be canceled once you have at least 20% in home equity, which reduces your monthly mortgage payments.
- Faster closing times: It’s not uncommon for conventional loans to close faster than VA loans. If you need to get into your new home or refinance sooner rather than later, keep this perk in mind.
Cons
- Down payment requirement: Conventional loans require a down payment between 3% and 20%. If you don’t have the funds readily available, it could take some time to save up, further delaying the purchase of your new home.
- More stringent DTI guidelines: Conventional loans often have stricter debt-to-income (DTI) ratio requirements. So, qualifying for a loan could be challenging for those with higher levels of existing debt or lower income.
- Lowest interest rates for excellent credit borrowers only: If you have fair or poor credit, you likely won’t qualify for the advertised rate. Unfortunately, your borrowing costs will be higher over the life of the loan.
How to Know Which Loan is Right for You
If you qualify for both a VA loan and a conventional loan, it can be difficult to choose between the two. Here are some factors to keep in mind as you weigh the pros and cons of each to make an informed decision.
Assessing Your Eligibility
Even if you’re familiar with the general guidelines for VA loans and conventional loans, it’s worth getting pre-qualified with a few lenders for both types of mortgages. Doing so will give you a better idea of your approval odds, estimated borrowing power, and terms you may be eligible for.
Qualifying for both types of mortgages is a plus. Still, you may find that one is a much better deal for your finances than the other.
Evaluating Your Financial Situation
Do a detailed review of your finances. Take note of your current debt load and how much you have saved for a down payment. Calculating how much you can realistically afford to pay each month for a new mortgage is equally essential.
Remember, VA loans have more flexible lending guidelines, so a higher debt load may not be a deal-breaker. And you won’t need a down payment with a VA loan, so you don’t have to wait until you save a bundle to buy a home. VA loans also come with competitive terms, even if you don’t have perfect credit, and skip PMI, making your monthly mortgage payments more affordable.
Long-term Goals and Plans
Do you intend to occupy the home as your primary residence, or will you use it as a second home or an investment property? If it’s the latter, a conventional loan is the better fit, as VA loans cannot be used to buy homes you don’t plan to initially occupy.
Keep in mind that you’re free to convert your home to a rental property after 12 months of occupying it. So, a VA loan could work in this case and yield substantial cost savings over time.
When to Choose a VA Loan
A VA loan could make sense for your financial situation if:
- You meet the guidelines for the VA loan program.
- You’re having trouble qualifying for a conventional loan.
- You don’t want to make a down payment or pay PMI.
- You have fair credit and need a more flexible funding option.
- You qualify for both types of loans, but VA loans come with better terms.
When to Choose Conventional Loans
You might be better off with a conventional loan if:
- You’re ineligible for a VA loan.
- You have excellent credit and qualify for a low interest rate.
- You want to buy a second home or investment property.
- You can afford a 20% down payment.
- You are eligible for a VA loan but prefer not to pay a funding fee.
Conclusion: Final Recommendations for VA Loan vs Conventional Loan
In most instances, A VA loan is the better choice if you qualify. These mortgages offer 100% financing and competitive terms compared to conventional loans, and you won’t ever have to pay PMI. Plus, there are caps on how much lenders can charge for closing costs. Although there is a funding fee, the benefits of these home loan products often outweigh the costs.
That said, a strong credit score and a larger down payment could be the deal-breaker if you’re leaning towards a conventional loan. With this financial profile, you’ll likely get a competitive rate, skip the funding fee and steer clear of PMI.
