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VA, FHA or Conventional Home Loans: Which is Right for You?

conventional home loan

Comparing different loan types for your needs

Buying a home is a complicated process, and choosing the best type of mortgage is one of the first hurdles you’ll face. With so many mortgage options available to buyers, it can be difficult to know how to find the one that’s best for you. What’s right for one borrower may not be an option for another, so it’s important to do your research before making any decisions.

Whether you’re a first-time homebuyer or have gone through the mortgage shopping process a few times, it’s important to look at several loan types to determine which option(s) you’re eligible for and which best meets your needs and financial goals. In this guide, we’ll cover a few of the most common mortgage types.

VA loans

Best for: Active duty service members, veterans, certain Reserve and National Guard members, and some surviving spouses of deceased veterans.

The U.S. Department of Veterans Affairs (VA) insures a portion of mortgage loans made by private lenders through its VA Home Loan Program. That means the VA is not an actual lender, but, rather, it agrees to back loans issued to veterans by approved lenders. This guarantee allows lenders to offer better rates and terms to borrowers.

In fiscal year 2017, lenders distributed nearly $188.7 billion to eligible VA Home Loan borrowers across 740,339 guaranteed purchase and refinance loans.

VA loan eligibility

Active duty service members and veterans who have met minimum length of service requirements, certain Reserve and National Guard members, and some surviving spouses of deceased veterans are eligible for VA loans to fund the purchase of their primary residence.

Before you use your benefit for the first time, you’ll need to obtain a Certificate of Eligibility (COE) from the VA.

The minimum credit score requirement or maximum debt-to-income (DTI) ratio required varies by lender. The VA also does not cap your loan amount; however, it will only guarantee a certain amount on each loan, which varies by county.
 

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VA loan benefits

In most cases, VA loans do not require a down payment or mortgage insurance, and lenders cannot impose a prepayment penalty for paying your loan off early. Closing costs are also capped, which means you’ll have minimal out-of-pocket costs if you qualify.

However, your loan may require a 1% origination fee, and there are funding fees ranging from 1.25% to 3.3% depending on type of service, whether you make a down payment, and whether you’ve used the benefit before.

VA Interest Rate Reduction Refinance Loan (IRRRL)

The VA also offers a streamline refinance option for those who qualify for the VA Home Loan program and have already financed their property with a VA loan. The IRRRL allows borrowers to refinance into a lower interest rate or from an adjustable to fixed rate. The underwriting process is limited, which means that borrowers do not have to provide a lot of documentation or go through an extensive credit check or appraisal to qualify.

While you cannot receive cash from an IRRRL, although the VA does offer a separate cash-out refinance loan option; IRRRL proceeds can only be used to cover an existing VA loan.

As with a VA purchase loan, you may have to pay a funding fee when you close on your refinance. Loans may be billed as “no money out of pocket,” but this does not necessarily mean you will pay less to borrow. In order to offer this option, lenders include fees in your financing or charge higher interest rates.

FHA loans

Best for: First-time home buyers, buyers with poor credit history, or any homebuyer who is looking for a low down payment option.

Like the VA, the Federal Housing Administration (FHA) insures mortgages offered by private lenders to those who may not be eligible for the best rates on conventional loans, including those whose credit score is on the low side or who can’t meet the down payment requirements of conventional lenders. This government-backed program, which began in 1934, currently insures loans on 7.95 million single-family homes.

FHA loan eligibility

Borrowers must have a credit score of at least 580 to be eligible for an FHA loan with a 3.5% down payment. Those with credit scores between 500 and 579 may still qualify but will have to put 10% down. All applicants must provide proof of income. FHA loans can only be used for the borrower’s primary residence.

If you’ve filed for bankruptcy or had a foreclosure in recent years, you are more likely to qualify for an FHA mortgage than other types of loans.

FHA loan benefits

The minimal down payment and low credit score requirements make FHA loans a good option for first-time homebuyers and those who have limited or poor credit histories. Also, because FHA loans are backed by a government agency, interest rates are generally lower than borrowers would be eligible for with other lenders.

There are two things to know before taking on an FHA loan. First, the FHA sets annual loan limits, which means the amount you borrow may be capped below what your prospective home costs. This will vary based on geographic area, so look up limits near you.

The other consideration for FHA loans is the required mortgage insurance premium. You’ll pay 1.75% of your loan amount upfront as part of your closing costs as well as a monthly premium, which varies depending on your loan-to-value (LTV) ratio. Mortgage insurance allows the FHA to lend to riskier borrowers — it does not actually insure your investment — and is generally more expensive than private mortgage insurance on conventional loans.
 

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FHA Streamline Refinance

The FHA Streamline Refinance program allows homeowners who already have an FHA mortgage to refinance with limited underwriting. To be eligible, borrowers must be current on their payments and stand to benefit from a refinance with a lower interest rate, a lower monthly payment, or a switch from an adjustable rate to a fixed rate. Your original FHA loan must be at least 210 days old before you can apply to refinance.

Similar to IRRRLs, lenders may offer “no-cost” options, but that generally means you’ll pay a higher interest rate. The FHA Streamline Refinance program does, however, allow borrowers to receive a maximum of $500 in cash from their loans.

Conventional loans

Best for: Homebuyers with good credit and sufficient funds to cover a substantial down payment.

Conventional mortgages are offered by private lenders. They aren’t insured directly by a federal agency; rather, they are backed by government-sponsored companies like Fannie Mae and Freddie Mac. While conventional loans generally have stricter eligibility requirements than other loan types, they often offer better rates and significantly lower mortgage insurance premiums.

Purchase loan eligibility

Conventional home loans require a higher credit score than both FHA and VA mortgages. While some lenders will give you an offer with a score in the 620 range, many prefer ratings of at least 700.

According to mortgage data company Ellie Mae, the average FICO score for conventional purchase loans in April 2018 was 752. The same report showed an average LTV of 81% and a DTI between 24% and 36%.
 

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Purchase loan benefits

Borrowers with solid credit who qualify for a good interest rate may prefer a conventional mortgage because these loans are more flexible — they can be used for properties that are not the buyer’s primary residence — and do not have such high insurance requirements. Unlike insurance on FHA loans, private mortgage insurance is cheaper and requires little or no payment upfront.

Once your LTV ratio drops below 80%, you generally don’t need to continue paying for insurance. If you put at least 20% down on your home, you won’t need insurance at all. Although interest rates are higher on average for conventional mortgages than FHA loans, the limited mortgage insurance requirement can make the former cheaper overall.

Conventional loan refinancing

Refinancing to a conventional loan can result in a lower interest rate or, if you start with an FHA loan, a lower mortgage insurance premium. Depending on your priorities, you can refinance into shorter or longer term, a different monthly payment, or a better rate or get cash out to help pay for other expenses.

One thing to consider before refinancing is that you’ll need to pay closing costs all over again, so if you aren’t planning to be in your home for more than a few years, you may not be able to recoup what you spend on the process. Be sure to check your current mortgage terms for any prepayment penalties or other fees to refinance as well.

Which mortgage is right for me?

Military families may assume that a VA home loan — or for new homebuyers, an FHA mortgage — is the best option because similar borrowers choose them, but this won’t necessarily be the case. A conventional loan may offer a better rate depending on your credit, for example, so don’t assume that a specialized mortgage program is the only way to go.

Also, keep in mind that there are other mortgage types available besides VA, FHA, and conventional loans. Teachers may be eligible for loans like California’s Extra Credit Teacher Home Purchase Program, and some lenders may offer special assistance to physicians or other professionals — Citizens Bank’s Doctor Loan Mortgage Program, for example. Borrowers should always shop around with different lenders to find the best rate and terms for which they are eligible.

How to shop for loan offers

Not all lenders offer VA, FHA, and conventional loans. The Department of Veterans Affairs and the Federal Housing Administration simply insure loans made by private lenders who opt into these programs, while conventional loans are generally made by private lenders and backed by private insurers like Fannie Mae and Freddie Mac.

As you shop around, try to get offers from those that participate in multiple types so you can do a side-by-side comparison with each lender.

Compare multiple offers before choosing

When you’re shopping for a home loan, don’t settle for the first offer you receive. Mortgage rates have been on the rise since late 2017 and are currently hovering around their highest point in three years. The gap between the lowest rates available and the highest has increased as well, which means comparing offers from different lenders could save you a lot of money over time.

According to LendingTree’s June 5 Mortgage Rate Comparison Index, the median spread between the highest and lowest rates available on purchase loans is 0.65%, which means homebuyers could save more than 10% of their loan amount by shopping around. For refinances, that gap widens even further to 0.75% and translates to the highest potential savings on record since 2013.

It’s easy to compare mortgage rates online on sites like LendingTree and with specific lenders. Comparison shopping can save you tens of thousands of dollars over the life of your loan, so it’s important to find the best deal that meets your current financial needs and your long-term goals.

What to look for when comparing offers

Low rates are certainly attractive, but they’re not the only factor to consider when you compare offers. One lender may have a lower rate but charge a higher origination fee or require prepayment penalties for paying your loan off early, which could actually cost you more in the long run than options with slightly higher rates.

Always look at rate lock periods, mortgage insurance requirements, fees, and penalties, and make sure you are comparing similar terms and types of mortgages — don’t compare fixed rate offers directly with adjustable rate offers, for example. It’s also important to build a relationship with your lender so you know how they will answer questions, help solve problems, or work with you if your circumstances change.

There is no one-size-fits-all home loan

Which mortgage is right for you depends on many factors, including your credit history, your current assets, and your financial priorities. Before you make any decisions, check with at least three lenders who offer a variety of loan types to determine what you qualify for and where you’ll get the best deal.

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