When it comes to financing a home purchase, two of the most common options available to borrowers are VA loans and conventional loans. VA loans are a special benefit offered to veterans, active-duty service members, and certain members of the National Guard and Reserves, backed by the U.S. Department of Veterans Affairs.
These loans are designed to make homeownership more accessible to those who have served in the military, offering significant advantages such as no down payment requirement, competitive interest rates, and no need for private mortgage insurance (PMI). On the other hand, conventional loans are widely available to all borrowers, including those who do not have military service, and are not backed by the government.
Conventional loans are offered by private lenders, such as banks, credit unions, and mortgage companies, and they come with their own set of advantages and drawbacks, including flexibility in property types and loan terms, but often require higher credit scores and down payments.
This article aims to provide an in-depth comparison of VA loans and conventional loans, highlighting the pros and cons of each to help you make an informed decision about which loan type best suits your needs. Whether you are a veteran exploring your VA loan benefits or a civilian considering a conventional loan, understanding the differences between these two types of loans is crucial for selecting the right mortgage option.
We will explore the benefits such as lower interest rates and flexible credit requirements offered by VA loans, as well as the wider accessibility and versatility of conventional loans. Additionally, we will discuss the potential downsides, including the VA funding fee and stricter property standards associated with VA loans, and the higher down payment and credit requirements often needed for conventional loans.
Pros Of VA Loans
1. No Down Payment Required
One of the most significant advantages of a VA loan is that it requires no down payment. This benefit is particularly appealing to first-time homebuyers or those who may not have significant savings. The ability to finance 100% of the home’s purchase price allows veterans to buy a home without the financial burden of saving for a down payment, which can be a significant barrier in many housing markets.
2. No Private Mortgage Insurance (PMI)
Unlike conventional loans, VA loans do not require private mortgage insurance (PMI), even if you put down less than 20%. PMI can add hundreds of dollars to your monthly mortgage payment, so avoiding this cost is a substantial financial benefit. The absence of PMI makes VA loans more affordable in the long run and can result in significant savings over the life of the loan.
3. Competitive Interest Rates
VA loans often offer lower interest rates compared to conventional loans. The government backing of VA loans reduces the risk for lenders, allowing them to offer more competitive rates. Lower interest rates mean lower monthly payments and less money spent on interest over the life of the loan, making VA loans a cost-effective option for eligible borrowers.
4. Flexible Credit Requirements
VA loans typically have more lenient credit requirements than conventional loans. While a good credit score is still important, VA loans are designed to help veterans and active-duty service members who may not have perfect credit. This flexibility can make it easier for borrowers to qualify for a VA loan, even if they have a lower credit score or past credit issues.
5. No Prepayment Penalties
VA loans do not come with prepayment penalties, meaning you can pay off your loan early without incurring additional fees. This is a significant advantage for borrowers who want the flexibility to pay down their mortgage faster or refinance to take advantage of lower interest rates in the future. The absence of prepayment penalties allows borrowers to save money on interest and reduce their overall debt more quickly.
6. Assistance For Struggling Borrowers
The VA offers various programs to help borrowers who are struggling to make their mortgage payments. These programs include financial counseling, loan modifications, and other forms of assistance to help veterans avoid foreclosure. This level of support is unique to VA loans and can provide peace of mind to borrowers who may face financial difficulties during the life of the loan.
7. Assumable Loans
VA loans are assumable, meaning that if you sell your home, the buyer can take over your existing VA loan, provided they qualify. This can be a significant selling point in a rising interest rate environment, as the buyer may be able to assume your loan at a lower interest rate than they could get with a new loan. An assumable loan can make your home more attractive to potential buyers and help you sell it more quickly.
8. No Loan Limits With Full Entitlement
As of 2020, VA loans no longer have loan limits for borrowers with full entitlement, allowing them to purchase more expensive homes without needing a jumbo loan. This change provides greater flexibility for veterans looking to buy in high-cost areas and eliminates the need for a large down payment on higher-priced homes. The absence of loan limits makes VA loans more versatile and accommodating to a wider range of homebuyers.
9. Funding Fee Can Be Financed
The VA loan funding fee, which helps offset the cost of the VA loan program, can be rolled into the loan amount rather than paid upfront. This option reduces the immediate out-of-pocket costs for borrowers and allows them to finance the fee over the life of the loan. While this increases the total loan amount and monthly payments slightly, it provides valuable flexibility for those who may not have the funds to pay the fee at closing.
10. No Expiration On Benefits
The benefits of a VA loan do not expire, meaning eligible veterans and service members can use them at any point in their lives. Whether you’re a young service member buying your first home or a retired veteran purchasing a new property, your VA loan benefits remain available. This lifelong eligibility provides ongoing support and flexibility for veterans at every stage of homeownership.
Cons Of VA Loans
1. VA Funding Fee
While VA loans do not require PMI, they do come with a funding fee, which can range from 1.4% to 3.6% of the loan amount, depending on your down payment and whether it’s your first use of the VA loan benefit. This fee can add to the cost of the loan, although it can be financed into the loan amount. The funding fee is a unique expense associated with VA loans that borrowers need to consider when evaluating the overall cost of the loan.
2. Strict Property Requirements
VA loans have strict property requirements, known as the Minimum Property Requirements (MPRs), to ensure that homes purchased with a VA loan are safe, sound, and sanitary. These requirements can make it difficult to purchase fixer-uppers or properties that need significant repairs. The MPRs are designed to protect veterans, but they can also limit the types of homes that qualify for VA financing, potentially narrowing your options.
3. Primary Residence Requirement
VA loans are intended for primary residences only, meaning you cannot use a VA loan to purchase a vacation home or investment property. This limitation restricts the flexibility of VA loans for borrowers who may want to buy multiple properties or who are interested in real estate investment. The primary residence requirement is a significant limitation for those looking to diversify their real estate holdings.
4. Funding Fee Waiver Not Automatic
While some veterans are exempt from the VA funding fee, such as those with a service-connected disability, the waiver is not automatic. Veterans must apply for the exemption and provide documentation to prove their eligibility. This additional step can delay the loan process and requires careful attention to detail to ensure that the waiver is granted. The need to apply for a funding fee waiver adds complexity to the loan process for eligible veterans.
5. Potential For Longer Closing Times
The additional paperwork and requirements associated with VA loans can lead to longer closing times compared to conventional loans. This can be a disadvantage in competitive housing markets where sellers are looking for a quick and smooth transaction. The potential for longer closing times is a consideration for borrowers who need to move quickly or who are competing with other buyers in a hot market.
6. Limits On Co-Borrowers
VA loans have restrictions on who can be a co-borrower. Typically, only a spouse or another veteran can be a co-borrower on a VA loan. This limitation can be a disadvantage for borrowers who want to include a non-spouse or non-veteran co-borrower, such as a friend or family member, in the loan. The restrictions on co-borrowers can limit your flexibility in structuring the loan and may require you to explore other financing options.
7. Appraisal Process Can Be Challenging
The VA appraisal process is known for being more stringent than conventional loan appraisals. VA appraisers must ensure that the property meets the MPRs and that the sale price aligns with the home’s market value. If the appraisal comes in lower than the purchase price, you may need to renegotiate the sale or bring additional funds to the table. The appraisal process can be a hurdle for VA loan borrowers, particularly in competitive markets where home prices are rising rapidly.
8. Funding Fee Can Increase With Subsequent Use
If you use your VA loan benefits multiple times, the funding fee may increase with each subsequent use, unless you make a down payment of 5% or more. This increase can add to the overall cost of using VA loans for repeat home purchases. The escalating funding fee with subsequent use is a consideration for veterans who plan to buy multiple homes with VA loans.
9. Limited Availability Of VA Loan Lenders
While VA loans are widely available, not all lenders offer them, and the level of experience and service can vary significantly among lenders. Finding a lender who specializes in VA loans and understands the unique aspects of the program is crucial, but it may require more research and effort. The limited availability of knowledgeable VA loan lenders can be a drawback for borrowers who want a smooth and efficient loan process.
10. Competitive Advantage May Be Limited In Some Markets
In some competitive housing markets, sellers may prefer offers from buyers with conventional loans over those with VA loans due to the perceived complexity and potential delays associated with VA financing. This perception, whether accurate or not, can put VA loan borrowers at a disadvantage in bidding wars or negotiations. The potential competitive disadvantage in certain markets is a factor for veterans to consider when choosing between a VA loan and other financing options.
Pros Of Conventional Loans
1. Widely Available
Conventional loans are widely available through a variety of lenders, including banks, credit unions, and online mortgage companies. This widespread availability gives borrowers the ability to shop around for the best rates and terms, ensuring that they find a loan that meets their needs. The competitive nature of the conventional loan market can result in better deals for borrowers.
2. No Funding Fee
Unlike VA loans, conventional loans do not come with a funding fee. This can reduce the overall cost of the loan, particularly for borrowers who would otherwise have to finance the VA funding fee into their loan amount. The absence of a funding fee is a financial advantage for borrowers who want to minimize the upfront costs associated with obtaining a mortgage.
3. Flexibility In Property Types
Conventional loans offer greater flexibility in the types of properties that can be financed. In addition to primary residences, conventional loans can be used to purchase vacation homes, investment properties, and multi-unit properties. This flexibility makes conventional loans an attractive option for borrowers interested in diversifying their real estate portfolio or purchasing non-primary residences.
4. No Primary Residence Requirement
Unlike VA loans, conventional loans do not have a primary residence requirement, allowing borrowers to use the loan for second homes or investment properties. This flexibility is beneficial for borrowers who want to own multiple properties or who are looking to invest in real estate. The lack of a primary residence requirement makes conventional loans more versatile than VA loans.
5. Option To Avoid Private Mortgage Insurance (PMI)
Borrowers who make a down payment of 20% or more on a conventional loan can avoid paying private mortgage insurance (PMI). Avoiding PMI reduces the monthly mortgage payment and the overall cost of the loan. This is a significant advantage for borrowers who have enough savings to make a large down payment.
6. No VA Appraisal Process
Conventional loans do not require the VA appraisal process, which can be more stringent and time-consuming. Without the VA’s Minimum Property Requirements (MPRs), the appraisal process for a conventional loan can be faster and more straightforward. The absence of the VA appraisal process can be an advantage in competitive housing markets where speed is essential.
7. Flexible Down Payment Options
Conventional loans offer a range of down payment options, from as low as 3% for first-time homebuyers to 20% or more to avoid PMI. This flexibility allows borrowers to choose a down payment that fits their financial situation and goals. The ability to customize the down payment is a key advantage of conventional loans.
8. No Military Service Requirement
Conventional loans are available to all borrowers, regardless of military service. This inclusivity makes conventional loans accessible to a broader range of people, including civilians, non-military government employees, and those without VA loan eligibility. The lack of a military service requirement makes conventional loans a widely available financing option.
9. Faster Closing Process
The closing process for conventional loans can be faster than for VA loans, particularly if the lender has streamlined procedures and fewer requirements. The faster closing process can be advantageous in competitive markets where a quick transaction can make the difference in securing a property. The potential for a faster closing is a key consideration for borrowers who need to move quickly.
10. No Limits On Loan Amounts
Conventional loans do not have loan limits like VA loans, providing more flexibility for borrowers looking to purchase high-priced homes. While loans above certain thresholds may require a jumbo loan, conventional financing is available for any loan amount as long as the borrower qualifies. The absence of loan limits makes conventional loans suitable for a wider range of property types and prices.
Cons Of Conventional Loans
1. Higher Down Payment Requirements
Conventional loans often require higher down payments compared to VA loans. While it is possible to make a down payment as low as 3%, most borrowers aim for 20% to avoid PMI. The higher down payment requirement can be a barrier for some borrowers, particularly first-time homebuyers who may not have substantial savings.
2. Private Mortgage Insurance (PMI) Required
If you make a down payment of less than 20% on a conventional loan, you’ll be required to pay private mortgage insurance (PMI). PMI can add significantly to your monthly mortgage payment and increase the overall cost of the loan. The requirement for PMI is a disadvantage for borrowers who cannot afford a 20% down payment.
3. Stricter Credit Requirements
Conventional loans typically have stricter credit requirements than VA loans. Borrowers need a higher credit score to qualify for competitive interest rates and terms. Those with lower credit scores may face higher interest rates, larger down payment requirements, or difficulty qualifying for a conventional loan altogether.
4. No Government Guarantee
Conventional loans do not have the government guarantee that VA loans offer. This lack of guarantee makes conventional loans riskier for lenders, which can result in stricter qualification criteria and higher interest rates for some borrowers. The absence of a government guarantee is a significant difference between conventional loans and VA loans.
5. No Assumable Loan Option
Most conventional loans are not assumable, meaning that the loan cannot be transferred to a new buyer if you sell your home. This lack of an assumable loan option can make it more challenging to sell your home, particularly in a rising interest rate environment. The inability to assume a loan is a disadvantage of conventional loans compared to VA loans.
6. No Special Assistance Programs
Unlike VA loans, conventional loans do not offer special assistance programs for struggling borrowers. If you face financial difficulties, you’ll need to work directly with your lender to explore options such as loan modification or refinancing. The lack of dedicated assistance programs can make it more challenging to manage your mortgage during tough times.
7. Potential For Higher Interest Rates
Depending on your credit score and financial situation, conventional loans can come with higher interest rates compared to VA loans. The higher interest rates increase the overall cost of the loan and result in higher monthly payments. The potential for higher interest rates is a consideration for borrowers with less-than-perfect credit.
8. More Limited Loan Terms
While conventional loans offer flexibility in loan terms, they may not provide the same range of options as VA loans. For example, VA loans can offer longer repayment terms or more favorable conditions for specific borrower circumstances. The more limited loan terms of conventional loans may not meet the needs of all borrowers.
9. Impact On Debt-to-Income Ratio
Conventional loans often have stricter requirements for debt-to-income (DTI) ratios compared to VA loans. If you have significant existing debt, you may find it more challenging to qualify for a conventional loan or may be offered less favorable terms. The impact on DTI ratio is a consideration for borrowers with substantial financial obligations.
10. No Funding Fee Exemption
Conventional loans do not offer exemptions from certain fees, such as a funding fee, based on veteran status or disability. All borrowers are subject to the same fees and charges, regardless of their background. The lack of fee exemptions is a difference from VA loans that can impact the overall cost of a conventional loan.
Conclusion
Choosing between a VA loan and a conventional loan depends on your individual circumstances, financial situation, and home-buying goals. VA loans offer significant advantages for eligible veterans and service members, including no down payment, no PMI, and competitive interest rates. However, they also come with specific requirements and potential drawbacks, such as the VA funding fee and stricter property standards.
Conventional loans, on the other hand, provide broader access to financing with flexibility in property types and no military service requirement. They can be an excellent option for borrowers who can meet the credit and down payment requirements but may come with higher overall costs due to PMI and higher interest rates.
Understanding the pros and cons of each loan type is essential for making an informed decision that aligns with your long-term financial goals. Whether you’re a veteran looking to take advantage of your VA loan benefits or a civilian exploring conventional loan options, carefully consider your needs, budget, and eligibility to choose the loan that best suits your path to homeownership.