In the mortgage world, there are three primary types of loans – VA loans, conventional loans, and FHA loans.
Though they serve the same purpose, there are enough differences between the three to make them each entirely different loan types. Knowing how each one functions can help you determine whether or not it’s the best financing option for you.
There is a fourth type of loan in USDA loans, but with a market share of 1% of total home loans, it is a much more niche option. Still, there are many benefits to the USDA loan – you can read about the pros and cons of USDA vs VA loans here.
VA Loan vs. Conventional Loan – The Basics
When it comes to home financing, understanding the differences between VA loans and conventional loans is essential. While both loan options serve the purpose of providing funds for purchasing a home, there are distinct characteristics that set them apart. VA loans are backed by the Department of Veterans Affairs and are exclusively available to eligible Veterans, active-duty service members, and their families. These loans offer benefits such as no down payment and lower interest rates.
On the other hand, conventional loans are not government-backed and typically require a higher down payment. However, they provide greater flexibility and are available to a wider range of borrowers.
Refer to the table below to better understand the key differences between conventional loans, VA loans, and FHA loans.
|Loan Characteristic||Conventional Loans||VA Loans||FHA Loans|
|Loan Eligibility||Available to all eligible borrowers, including civilians and Veterans||Available to active duty service members, Veterans, and certain surviving spouses||Available to a wide range of borrowers, including first-time homebuyers|
|Credit Requirements||Generally stricter credit requirements; higher credit score may be needed||More flexible credit requirements, making it easier for some borrowers to qualify||More lenient credit requirements, allowing for lower credit scores|
|Down Payment||Typically requires a higher down payment, usually ranging from 3% to 20% of the purchase price||Generally offers the option for a zero down payment||Requires a minimum down payment of 3.5% of the purchase price|
|Mortgage Insurance||Private Mortgage Insurance (PMI) is required if the down payment is less than 20% of the purchase price||No mortgage insurance is required||Mortgage Insurance Premium (MIP) is required|
|Interest Rates||Interest rates may vary based on credit score, down payment, and market conditions||Interest rates are typically competitive and often lower than conventional loans||Interest rates are typically competitive|
|Closing Costs||Closing costs may vary and can be negotiated between the buyer and seller||Closing costs are generally limited and can be paid by the seller or rolled into the loan||Closing costs may vary and can be negotiated between the buyer and seller|
|Property Requirements||Can be used for various property types, including primary residences, second homes, and investment properties||Can be used for primary residences, including single-family homes, townhomes, and condominiums||Can be used for various property types, including primary residences|
|Loan Limits||Loan limits set by the loan type, loan-to-value ratio, and location||Loan limits set by the VA and vary based on the county or area||Loan limits set by the FHA and vary based on the count|
One of the biggest differences between VA loans and conventional loans is that VA loans are limited to owner-occupied properties only. Occupancy must be either by the Veteran or by the Veteran’s spouse.
Conventional loans are available to buyers or owners of vacation homes, investment properties, and owner-occupied homes. There is no specific occupancy requirement; however, rules and guidelines for non-owner-occupied properties are more strict than those for owner-occupied ones.
For example, in the case of a vacation home, conventional financing will require the borrower to either make a larger down payment or to have greater equity than would be the case with an owner-occupied property.
The restrictions with investment properties are even more extreme. Not only will a larger down payment or equity position be required, but specific methods will be used to recognize any rental income used to qualify for the loan.
The lender may even require the borrower to have a specific amount of cash reserves – in the form of liquid assets – after closing on the loan. None of those issues apply to VA loans since non-owner-occupied properties are not permitted.
Mortgage loan limits for both VA and traditional mortgage loans are essentially the same. For 2023, the maximum loan amount for a single-family property in most markets is $726,200, up from $647,200 in 2022. The limit rises to up to $1,089,300 in areas designated as high-cost housing areas. (The higher VA loan amounts are generally determined by county.)
VA loan borrowers with full entitlement have more flexibility in exceeding the standard loan limits. With full entitlement, eligible Veterans can borrow beyond the loan limits without requiring a down payment. This provides them with greater access to financing for higher-priced homes. VA loan limits only apply to those with partial entitlement, meaning they’ve used their VA loan before and haven’t yet had their entitlement restored
The loan limits for conventional loans and VA loans differ in how they are determined and the maximum amount that can be borrowed without additional stipulations, such as a higher credit score, interest rate, or down payment.
- Conventional Loan Limits: Conventional loans have loan limits set by the Federal Housing Finance Agency (FHFA). These limits are based on the conforming loan limit and vary by location. Higher-cost areas generally have higher loan limits.
- VA Loan Limits: VA loans have their loan limits set by the Department of Veterans Affairs (VA). The VA loan limits are generally aligned with the conforming loan limits set by the FHFA. However, in certain high-cost areas, VA loan limits may exceed conforming loan limits, allowing eligible Veterans to borrow a higher amount without needing a down payment.
It’s recommended to consult with lenders or mortgage professionals to understand the specific loan limits based on individual circumstances and the current guidelines. Also, check out our blog about VA loan limits to find loan limits for high-cost counties.
If you exceed the conventional loan limits, you may be able to qualify for what’s known as a jumbo mortgage. That’s any loan where the amount exceeds the conventional limits.
Banks and other financial institutions typically fund jumbo loans. As such, they have their own rules and guidelines, which are generally more strict with regard to the down payment, income, and credit requirements.
You can get a VA loan in excess of the published limits, but you must qualify based on income.
In addition, you’ll generally be required to make a down payment equal to 25% of the loan amount that exceeds the published limits.
If the value of the property exceeds published loan limits for the county where it’s located, you probably won’t be eligible for 100% financing.
Interest Rates and Loan Fees
Interest rates for VA loans are usually lower than traditional loans. Last year, the average interest rate for a VA loan was 4.48%, while conventional loans had an average interest rate of 4.78% and FHA loans had an average interest rate of 4.86%, according to HMDA.
In each case, there’s a base interest rate that’s adjusted for certain factors. Credit score and loan size are common adjustment factors that can result in higher rates.
But conventional loans will also make adjustments for other factors, such as the size of the down payment on a purchase or equity in a refinance property.
It is a good idea to compare both VA Loan rates and conventional mortgage rates before locking in your loan. Discuss with your lender to determine which mortgage will be best for you depending on your circumstances.
Down Payment Requirements
This is an area where VA loans and traditional loans go their separate ways. One of the most typical features of a VA loan is that it offers 100% financing – translating into a zero down payment loan.
By contrast, FHA loans require a minimum down payment of 3.5%. And in certain circumstances, such as with a low credit score, the down payment requirement may increase to 10%.
The typical minimum down payment on a conventional mortgage is 5%, though there are loan programs for first-time homebuyers allowing down payments as low as 3%.
However, a conventional mortgage may not be approved with a minimum down payment due to borrower profile factors like credit and income. The borrower may be required to make a larger down payment to qualify for the loan.
As mentioned above, the only time a down payment is required on a VA loan is when the loan exceeds published loan limits. But a veteran can avoid that outcome entirely by staying within the limits.
The minimum credit score requirement for conventional mortgages is 620. This is a requirement not only of Fannie Mae and Freddie Mac, but also of private mortgage insurance companies.
Credit score requirements for FHA mortgages are generally more flexible. You’ll typically need a credit score minimum of 580 to qualify for a down payment of 3.5%.
But if your score is below 580, a 10% down payment will be required. Many individual mortgage lenders may refuse to make a loan at all to a borrower with a credit score below 580.
Technically speaking, VA loans don’t have a credit score minimum. However, the borrower does need to have clean credit for at least the past 12 months, particularly for their rent or mortgage payment.
Also, a minimum of two years must pass since the discharge of a Chapter 7 bankruptcy or a foreclosure before they are eligible for a VA loan. The borrower must show a clean credit history during that time.
The waiting period extends to three years if the foreclosure was on a VA loan. Put another way, where credit is concerned, VA loans rely more on actual credit history than on a credit score.
But much like FHA loans, a lender may impose a minimum credit score, which typically will be either 580 or 620. Lenders do have the ability to impose such limits within the VA loan program.
Of all the requirements involved in getting a mortgage, income qualification is probably the one providing the most flexibility.
Income qualification starts with a debt-to-income ratio, commonly referred to as DTI. That’s your recurring monthly debts divided by your stable monthly income.
DTI has two numbers. The first is your new house payment, divided by your stable monthly income.
The house payment comprises the principal and interest on the mortgage loan itself, property taxes, homeowner’s insurance, monthly mortgage insurance premiums, and any homeowner’s association dues if required.
The total of this payment is frequently referred to as “PITI” – short for principal, interest, taxes, and insurance.
The second DTI ratio – which is usually the most important – takes into account your total recurring monthly debt, including your new PITI. It will add monthly credit card payments, car payments, student loan payments, and other obligations such as child support, alimony, or the negative cash flow on other real estate owned.
On conventional mortgages, the housing DTI is generally limited to 28%, while total DTI is 36%. However, these ratios are routinely exceeded, especially when the borrower makes a large down payment on the property, has excellent credit, large cash reserves after closing, or will be reducing their monthly house payment.
On FHA loans, the housing ratio is 31%, while total debt is 43%. Again, these ratios are often exceeded when compensating factors are present.
VA Loan Income Qualification
Income qualification for VA loans is different. There is no specific housing DTI, but the total DTI is usually limited to 41%. However, that limit is frequently exceeded with good compensating factors. Many lenders will go as high as 50%.
But what distinguishes VA loans from other loan types is that DTI isn’t the only income factor. VA loans also rely on what’s known as the residual income method. It calculates the amount of money available after paying your housing and other fixed payments.
It starts with your stable monthly income, then subtracts the new house payment, recurring monthly debts, income taxes, utilities, and even an allowance for your household family size. The amount left over should be a positive number.
While it may seem VA loans have a higher income qualification standard, using two qualifying methods, the opposite is closer to the truth. A healthy residual income balance can be a justification for approving a loan with a DTI over 41%.
Mortgage Insurance Requirements
Mortgage insurance is one of the areas where VA loans make a near-complete departure from traditional loans, whether conventional or FHA.
On FHA loans, mortgage insurance is referred to as MIP, or mortgage insurance premium. It has two components, the upfront premium and the monthly premium.
The upfront premium is 1.75% on purchases, and that amount is typically added on top of the base mortgage amount. Monthly MIP can range from 0.40% to 0.75% of the total loan amount.
On a $200,000 mortgage, a 0.55% monthly MIP would translate to a $1,100 annual premium or about $92 per month added to the monthly mortgage payment.
Conventional mortgages don’t have an upfront mortgage insurance premium. But monthly PMI applies on any loan with a down payment or equity of less than 20% of the property value.
The exact amount of the monthly PMI payment will depend on several factors, including your actual equity in the property and your credit score range.
For example, if you purchase a property with a 5% down payment and you have a credit score of just over 700, the annual premium rate on a $200,000 loan will be 0.78%. That will result in an annual premium of $1,560, or a monthly premium of $130.
VA Mortgage Insurance – The VA Funding Fee
There is no monthly mortgage insurance premium on VA loans. There is only a one-time, upfront premium, referred to as the VA funding fee. However, it is also possible to have the funding fee waived if you have a VA Service-Connected Disability Rating.
- VA Purchase or Construction Loan: 2.15% of the loan amount for first-time use, 3.3% for subsequent uses.
- VA Cash-out Refinance: 2.15% for first-time use, 3.3% for subsequent uses.
- Interest Rate Reduction Refinance Loan (IRRRLs): 0.5%, regardless of equity.
The funding fee is typically added to the loan amount, which means the veteran can conceivably owe more on the property than it’s worth.
Final Thoughts on VA Loans vs. Traditional Loans
As you can see from the information above, each of the three loan types has advantages and limitations.
But generally speaking, VA loans have the most advantages and the fewest limitations.
Consider yourself fortunate if you’re an eligible veteran or current member of the military.
The absence of a down payment requirement or monthly mortgage insurance premiums gives VA loans a serious advantage when it comes to acquiring or maintaining a home.
Equal Housing Opportunity. The Department of Veterans Affairs affirmatively administers the VA Home Loan Program by assuring that all Veterans are given an equal opportunity to buy homes with VA assistance. Federal law requires all VA Home Loan Program participants – builders, brokers, and lenders offering housing for sale with VA financing – must comply with Fair Housing Laws and may not discriminate based on the race, color, religion, sex, handicap, familial status, or national origin of the Veteran.