Keep reading to learn which loan program may be right for you.
FHA Loans – What are They and How do they Work?
FHA loans are for borrowers with less than perfect credit, low income, or any other unique circumstances. Because the FHA guarantees these loans, lenders can have more flexible guidelines.
The Federal Housing Administration is a government agency that backs FHA-approved lenders. This means they promise lenders they’ll pay them back a portion of the funds they lost if an FHA borrower defaults on their loan.
This only occurs if the FHA lender follows the FHA guidelines, which fortunately has relaxed underwriting requirements.
The FHA doesn’t underwrite or fund the loans – only FHA-approved lenders handle that part. The FHA holds the guarantee for lenders though, so they can write loans for ‘riskier’ borrowers.
You don’t have to belong to a specific group or have a certain job to secure an FHA loan. It’s the most common program for borrowers that don’t qualify for conventional financing.
VA Loans – What are They and How do they Work?
VA loans are for veterans of the military or active members who served at least 90 days. In some cases, surviving spouses of veterans who lost their lives during or due to their service may be eligible too.
When you look at FHA loans vs VA loans, you’ll notice a large similarity – the VA guarantees VA loans like the FHA guarantees FHA loans. This is how VA-approved lenders can offer flexible guidelines for those who served our country.
VA loans have some more attractive features for veterans. For example, they don’t need a down payment, there isn’t a maximum debt-to-income ratio they must meet, and there isn’t mortgage insurance.
However, VA loans have funding fees for every loan you borrow. The funding fee goes directly to the Department of Veterans Affairs and is how they continue to guarantee loans for veterans. You can finance the cost in your loan, paying it over the 15 to 30-year term if you can’t afford it upfront.
Property Type – FHA Loans vs VA Loans
FHA loans and VA loans are similar in their property requirements. In both cases, the home must be your primary residence. This means you’ll live there year-round. You can have a second home (vacation home), but you must live in this property most of the year and you can’t rent it out.
The best option for borrowers looking to buy an investment home to either fix and flip or buy and rent out is a conventional loan. If this interests you, contact us and we’ll help you learn more.
Both FHA loans and VA loans require the home to be in safe, sound, and sanitary condition. Each loan program has specific Minimum Appraisal Requirements too. They aren’t anything too tough to meet and are in your best interests to ensure the house is a good investment.
Down Payments – FHA Loans vs VA Loans
A major difference between FHA loans and VA loans is the down payment requirements.
FHA loans require a 3.5% down payment. You may be eligible to receive the funds as a gift if you track them properly and follow the lender guidelines, but in general, you can only borrow up to 97.5% of the property’s value.
VA loans don’t require a down payment. You can borrow 100% of the property’s value, but this means you start homeownership with no equity. Veterans are free to put money down on the home even though it’s not required.
Loan Limits – FHA Loans vs VA Loans
Most loan programs have a loan limit or a maximum amount you can borrow, but VA loans are an exception.
FHA loans have loan limits that are based on where you live. The limit varies from $330,000 to $750,000 and is based on the average cost of homes in the area. If you live in a high-cost area, for example, you’ll have much higher loan limits, but if you live in a low-cost area, the limits will be much lower. There aren’t any exceptions to the FHA loan limits, so if you exceed those limits and are a veteran, you may want to look at the VA loan.
Like we said above, VA loans don’t have loan limits – the laws changed in 2020, allowing veterans to borrow as much as they prove they can afford. There is an exception, though. If you used your benefits before and defaulted, you’ll lose that portion of your eligibility, which means you can borrow less money, or if you borrow the same amount, you must make up the difference with a down payment.
Debt-to-Income Ratios – FHA Loans vs VA Loans
Your debt-to-income ratio is the percent of your monthly income spent towards paying off debt.
FHA loans have a maximum debt-to-income ratio of around 50%. However, if you have compensating factors, such as a high credit score or great loan payment history, lenders may be willing to accept a slightly higher DTI.
VA loans don’t have a maximum debt-to-income ratio. However, if you have a debt-to-income ratio higher than 41% you could be subject to a closer review of your finances.
Your debt-to-income ratio is going to be up for review no matter which loan you choose. Be open and honest with your loan officer to help him/her understand your situation and match you with the best loan.
Credit Scores – FHA Loans vs VA Loans
Your credit score is just as scrutinized as your debt-to-income ratio. Just like your DTI, you can find out your credit score and improve it before applying for a loan. for a loan.
FHA lenders require a 580-credit score or higher if you want to make a 3.5% down payment. If you have a credit score between 500 – 579, though, you may still be eligible but with a 10% down payment.
VA loans don’t have a minimum credit score requirement, but most lenders want a higher credit score because of the 0% down payment the VA requires. Most lenders require at least a 620-credit score, but there may be exceptions.
If you have a lower credit score, even if you are a veteran, the FHA loan may be a better choice unless you have to compensate for factors that allow a VA lender to approve your loan.
Mortgage Interest Rates – FHA Loans vs VA Loans
Borrowers always worry about the interest rates, but when comparing FHA and VA loans, there isn’t much comparison. They both offer competitive interest rates, but they vary based on your qualifying factors such as your credit score, debt-to-income ratio, location, and payment history.
To get the best interest rate, improve your credit score and debt-to-income ratio as much as possible. It’s also important to ensure you have enough assets to cover any required down payment or closing costs and you have stable employment.
Mortgage Insurance – FHA Loans vs VA Loans
Mortgage insurance protects the lender, ensuring they are reimbursed if you default on your loan.
This is an expense you don’t want to overlook.
FHA loans require mortgage insurance for every borrower for the life of the loan. FHA loans have an upfront mortgage insurance fee plus a monthly premium you must pay until the loan is paid in full.
VA loans do not require mortgage insurance. However, you’ll pay a funding fee when you take out the loan. The one-time fee ranges from 1.4% – 3.6% depending on how many times you’ve used your benefit, the reason for the loan, and your down payment.
When comparing your options, figure in the cost of mortgage insurance and/or the funding fee and look at the bottom line.
FHA and VA Loans – Pros and Cons
You have a lot to consider when choosing FHA loans vs VA loans. They aren’t a one-size-fits-all approach. Here are some pros and cons of each to consider.
PRO: Lower credit scores are allowed with an FHA mortgage
CON: If you have a lower credit score your initial down payment or interest rate may be higher
PRO: Your loan will not be affected by the amount of time spent in the military
CON: You will pay mortgage insurance for the life of the loan
PRO: The FHA doesn’t have income limits you must meet to be eligible.
CON: There are borrowing limits based on where you live.
PRO: You need only 3.5% down on the home
CON: Credit scores between 500 – 579 require a 10% down payment
PRO: You don’t need a down payment
CON: You’ll need a credit score of at least 620
PRO: You will not need mortgage insurance
CON: Your time spent in the military can affect the amount you will receive, and if you have a dishonorable discharge, you aren’t eligible
PRO: The VA has much more lenient debt-to-income ratio requirements
CON: Most borrowers pay a hefty funding fee to get the loan
PRO: VA loans are assumable
CON: You’ll lose your eligibility if you defaulted on a VA loan before
VA Funding Fee
What is the VA Funding Fee?
The VA funding fee is a one-time payment that either veterans, service members, or survivors might pay on a VA home loan.
The funding fee helps lower costs taxpayers pay by making the program more affordable without any down payments and monthly mortgage insurance fees.
Will I have to pay the VA funding fee?
If you’re using a VA home loan to buy, build, improve or repair your home then it is likely that you will need to pay the funding fees as long as certain requirements are met.
VA Funding Fee – Purchase and Construction Loans
|IF YOUR DOWN PAYMENT IS…||YOUR VA FUNDING FEE WILL BE…|
|First use||Less than 5%||2.3%|
|5% or more||1.65%|
|10% or more||1.4%|
|After first use||Less than 5%||3.6%|
|5% or more||1.65%|
|10% or more||1.4%|
VA Funding Fee – Cash-Out Refinancing
|FIRST USE||AFTER FIRST USE|
VA Funding Fee – IRRLs and Other VA Home Loans
|LOAN TYPE||VA FUNDING FEE|
|Interest Rate Reduction Refinancing Loans (IRRRLs)||0.5%|
|Manufactured home loans (not permanently affixed)||1%|
|Vendee loan, for purchasing VA-acquired property||2.25%|
Refinance Loan Options
VA IRRL and VA Streamline Refinance
The VA IRRRL, which stands for “Interest Rate Reduction Refinance Loan,” provides qualified veterans the ability to quickly and easily refinance their mortgage into a lower interest rate and payment. The IRRRL is also known as the VA streamline refinance.
To qualify, you only need to prove a timely mortgage payment history (no late payments in the last 12 months). Most lenders don’t re-verify your income, assets, credit score, or home value. Every lender differs, though, so it’s important to discuss your options and see what lenders require.
The point of the IRRRL program is to lower your payment or change your term. It’s not a loan that helps you tap into your home’s equity. It’s strictly meant to make your loan more affordable or benefit you in some way.
FHA Streamline Refinance
The FHA program also offers a streamlined program similar to the VA IRRRL program. This program also helps borrowers secure more attractive financing.
For example, if you had a 580-credit score when you bought your home, but you’ve since improved it to 700, you may be eligible for a lower interest rate.
The FHA streamline refinance doesn’t require proof of your income, assets, credit score, or home value. It focuses on your payment history. If you made your last 12 payments on time and the new loan has a lower rate, you’ll save money and be even better able to afford the loan.
The Final Decision
As you can see there is not one specific loan that fits everyone’s needs. It’s best to contact a mortgage professional to discuss FHA loans vs VA loans.
As a veteran, you are likely drawn to the VA loan but it’s not always the right choice.
Many people struggle with low credit scores and a high debt-to-income ratio. These factors can make it difficult when applying for a loan.
If you have a low credit score, an FHA loan may be the best option. However, for veterans with good to excellent scores, it is hard not to argue in favor of VA loans
For help getting started with your VA Loan or FHA loan click here.