VA Home Loans vs Conventional Loans: Which is Better for You?

If you’re an active military member veteran, or surviving spouse looking to buy a home you may be wondering whether to get a VA home loan or conventional loan. With two great options available, how do you choose? Let’s take an in-depth look at VA loans vs conventional loans so you can make the best decision for your situation.

An Overview of VA Home Loans

First, let’s start with an overview of VA loans. These mortgages are backed by the Department of Veterans Affairs and offered by private lenders. The main perks of VA loans include:

• No down payment required. VA loans allow 0% down, removing a major hurdle for buyers short on cash for a down payment.

• No mortgage insurance. With conventional loans under 20% down, you have to pay private mortgage insurance. But VA loans skip this added cost.

• Lower credit score requirements. VA loans can go as low as 580 for credit scores Many conventional loans want 620+ scores

• Looser debt-to-income rules. VA doesn’t set a DTI limit, just a soft cap at 41%. Conventional loans stick to tight 45% DTI rules.

• No prepayment penalties. VA loans let you pay off the balance early with no penalty fees.

• Capping on certain fees/costs. The VA limits how much lenders can charge for origination, application, and other fees.

• Interest rate discounts. On average, VA loan rates run 0.5% lower than conventional loan rates.

• Can be assumed by qualified buyers. If you sell the home, qualified buyers can assume the remainder of your VA loan.

The trade-off is VA loans come with upfront and recurring VA funding fees. Overall though, VA loans offer great flexibility and money-saving perks for eligible buyers.

Conventional Loan Basics

In contrast to VA loans, conventional loans are mortgages that conform to standards for purchase by Fannie Mae and Freddie Mac. Here are some key features of conventional loans:

• Typically need 3-20% down. Most lenders ask for at least 3-5% down on conventional loans. 20% down avoids mortgage insurance.

• Mortgage insurance with low down payments. Put less than 20% down on a conventional loan, and you’ll pay costly PMI monthly until you reach 20% equity.

• Minimum 620 credit scores. While some lenders go a bit lower, you’ll typically need at least 620-640 credit to qualify for a conventional loan.

• Strict 45% DTI limit. Conventional loans allow up to 50% DTI, but most lenders stick to 45% or lower for approval.

• Prepayment penalties possible. Your conventional loan may charge a penalty fee if you pay off the balance early in the first few years.

• No special military/vet requirements. Conventional loans have no unique eligibility requirements related to military service.

• Rates around 0.5% higher. Due to stricter criteria, conventional loan rates tend to be 0.5% or more higher than VA loan rates.

Conventional loans offer more flexibility on property types and don’t have VA fees. But they do require solid finances and larger down payments from borrowers.

Comparing Down Payments

One of the biggest differences between VA and conventional loans lies in the down payment requirements.

VA loans don’t require any down payment at all. Zero down means VA borrowers don’t need large cash reserves to buy. If your savings are limited, a $0 down VA mortgage can be a lifesaver.

On conventional loans, you’ll need between 3-20% down:

• 3-5% down: Minimum required by most lenders
• 10% down: A good target to keep mortgage insurance costs reasonable
• 20% down: Allows you to avoid mortgage insurance and qualify for better rates

The more you put down on a conventional loan, the better. But fewer buyers have tens of thousands available for 20% down. VA loan 0% down allow more buyers to purchase sooner.

Mortgage Insurance Comparison

Tied to down payments is the issue of mortgage insurance. With less than 20% down on a conventional loan, you have to pay private mortgage insurance, or PMI.

PMI is an added cost tacked onto your monthly mortgage payment. It protects the lender if you default, but costs the borrower 0.3-1% of the total loan amount annually. On a $250,000 loan, that’s an extra $750 to $2,500 in PMI payments each year.

VA loans skip PMI completely thanks to the VA home loan guarantee. The VA guarantee compensates lenders for up to 25% of losses if a VA borrower defaults. So lenders don’t require mortgage insurance.

No PMI is a big perk. On a $250,000 conventional loan with 5% down, here’s the mortgage insurance difference:

Conventional Loan:

• Down payment: $12,500
• Monthly mortgage insurance: $125
• Total yearly mortgage insurance: $1,500

VA Loan

• Down payment: $0
• Monthly mortgage insurance: $0
• Total yearly mortgage insurance: $0

That’s $1,500/year in PMI you bypass with a VA loan. Over a 30 year term, VA borrowers save $45,000+ on mortgage insurance costs.

Interest Rates Compared

VA loans consistently offer lower mortgage rates versus conventional loans. Here are average 30-year fixed rates:

• VA loan rates: 4.5% to 5.25%
• Conventional loan rates: 5% to 5.75%

While rates fluctuate, VA loans average 0.5% lower across lenders. This discount comes from the VA home loan guarantee protecting lenders from losses.

The 0.5% rate difference saves serious cash over your mortgage term. On a $300,000 loan amount, monthly principal and interest drops by $125-150 with a VA loan. Over 30 years, you’d save $45,000-$54,000 in interest costs.

Lower VA mortgage insurance and rates combine to save borrowers up to $100,000 over the life of the loan. That’s cash you can use for remodeling, college savings, retirement, or other big expenses.

Credit Score Flexibility

VA loans allow much lower credit scores than conventional mortgages. The minimum scores break down as:

• VA loans: 580 FICO
• Conventional loans: 620-640 FICO

Why the big difference? The VA guarantee gives lenders security to approve borrowers with lower scores who still show solid income, assets, and overall finances.

With a 580 FICO and strong finances otherwise, VA preapproval is achievable. But that same 580 score would fall short of most conventional loan requirements.

If your credit score is under 620, a VA loan likely offers the quickest path to ownership. You can work on improving your credit down the road.

Debt-to-Income Ratio Differences

Your debt-to-income ratio (DTI) measures total monthly debt payments divided by gross monthly income. It shows lenders how much income goes to cover debts.

Conventional loans stick to tight DTI limits of 45-50% for approval. But VA doesn’t impose a fixed DTI cap. Still, most lenders want VA loan DTI under 41%.

The less restrictive DTI helps buyers who have higher student loan, auto, credit card, or other debts manageable for their income level. Where conventional loans would deny you for too much DTI, VA offers more flexibility.

As an example:

• Gross monthly income: $6,000
• Total monthly debt payments: $2,400
• DTI: 40%

A 40% DTI would fall outside conventional loan limits but potentially work for a VA loan. This gives leeway to buyers with higher debt against their income.

Loan Fees Breakdown

Both VA and conventional loans charge some type of origination fees to process the mortgage. Conventional lending fees vary more, but often fall between 0.5-1.5% of the total loan amount.

VA loans have flat origination fees set at 1% of the loan total. But they cap many other lender fees like application and underwriting charges. There are also limits on what closing costs the VA allows.

In addition to lower origination fees, VA borrowers pay a VA funding fee. This upfront cost ranges from 1.4-3.6% of the loan total. On a $300,000 loan, that equals $4,200-$10,800 due at closing.

The VA funding fee is substantial. But active duty borrowers can request a waiver. And it can be rolled into the loan amount instead of paying out of pocket.

Overall, expect to pay 1-3% in fees for either loan type. But VA limits help control some origination and closing costs.

Early Repayment Options

VA mortgages allow prepayment of the balance at any time with no early payoff penalties. Even refinancing into a