Conventional Mortgage vs. VA Loan

Conventional mortgage vs. VA loan

By Michelle L. Black

For many people, buying a home represents one of life’s most exciting milestones. At the same time, it’s a process that requires you to make a lot of important decisions, starting with deciding how you plan to pay for your purchase.

If you’re like most homebuyers, you’ll probably need to borrow money to buy your home. But home loans, also called mortgages, don’t come in a one-size-fits-all option. You’ll have to figure out which home loan program makes the most sense for your situation.

Two common types of financing you may come across are conventional mortgages and VA loans. If you’re a member of the military (current or retired), you may be eligible to take out a VA loan to finance your home purchase. Conventional mortgages, meanwhile, can work for those with VA loan eligibility and other home buyers as well.

Read on for an in-depth overview of these two popular loan programs, including details on how to figure out if you’re eligible for each.

This guide will also help you examine the pros and cons of both conventional mortgages and VA loans to help you make more informed decisions on your journey to become a homeowner.

In this article

Conventional mortgages and how they work

Conventional mortgages are the most common way people purchase homes in the United States, according to Experian. This type of loan is not backed by the federal government, but by private lenders instead. Private lenders could be mortgage companies, banks, or credit unions.

Because conventional mortgages can come from a variety of different sources, qualifying for this type of loan can sometimes be a challenge. This may be especially true if you struggle with credit problems or have limited funds available for a down payment.

Conforming and non-conforming loans

There are two primary types of conventional mortgages — conforming and non-conforming loans. Here’s a look at the primary differences between these financing options.

Conforming loans

With a conforming loan, you need to satisfy specific requirements to qualify for financing.

These loan requirements are set by organizations known as government-sponsored enterprises (GSE). In the mortgage world, the two primary GSEs are Fannie Mae and Freddie Mac.

Fannie and Freddie, as they’re often called for short, buy conforming loans from lenders to help maintain a stable housing market. Once a GSE purchases a loan from a lender, that lender has more money available to loan to other would-be home buyers.

Non-conforming loans

Non-conforming loans do not meet Fannie Mae or Freddie Mac guidelines.

This means that the mortgage lender can’t sell the mortgage to a GSE in the future. Instead, the home loan could potentially sit on the lender’s books for decades.

This situation represents more risk for the lender. It also limits the number of new mortgage loans the lender can issue to new applicants in the meantime.

Because of this added risk for the lender, non-conforming loans tend to be harder to qualify for compared with conforming loans.

How to qualify for a conventional mortgage

Unless you need a non-conforming loan, you’ll typically have to meet loan requirements set by Fannie Mae or Freddie Mac to qualify for a conventional mortgage. You may also need to satisfy individual lender requirements (called overlays) as well.

Some general conventional mortgage requirements include:

  • FICO Score of 620 or higher. Some lenders offer conventional loans to borrowers with no credit scores.
  • Maximum debt-to-income ratio (DTI) of 49%. Many lenders prefer 43% or less. Mortgage lenders check your DTI to make sure you can afford the monthly payment for the loan.
  • Minimum down payment of 3% (or 5% for repeat home buyers). You’ll need to put down 20% to avoid private mortgage insurance on your loan.
  • Loan limit of $510,400. High-cost areas, such as Alaska and Hawaii, may feature loan limits as high as $765,600.
  • Property appraisal. The home will need to be safe, sound, and structurally intact so the lender can confirm that it’s making a good investment.

If you want to take out a non-conforming conventional loan, like a jumbo loan or portfolio loan, your individual lender will set its own requirements.

As a general rule, non-conforming loan requirements are tougher to satisfy. It’s common to need a higher credit score, bigger down payment, or lower DTI to qualify for this type of financing.

Pros and cons of conventional mortgages

When you’re researching any type of loan and whether it might be right for you, it’s helpful to examine the benefits and drawbacks. Below are some pros and cons of conventional mortgages.

Pros:

  • As a first-time home buyer, you only need a 3% down payment. If you’re a repeat home buyer, you can secure a conventional mortgage with 5% down. That being said, when you give the lender a bigger down payment you might be able to secure a lower interest rate.
  • There’s no funding fee. However, loan origination charges may apply.
  • Underwriting may be faster. Conventional loans tend to require less paperwork compared with government-insured mortgages like VA loans, FHA loans, and USDA loans. So, you might be able to close on your loan sooner if you opt for conventional financing.
  • You can use conventional mortgages to buy investment properties. Some government-backed mortgages, like VA loans, only work if you’re buying a primary residence.

Cons:

  • Conventional mortgages may be tough to qualify for if you have credit problems. You need a minimum credit score of at least 620 in most cases. Plus, if you’ve had a foreclosure or bankruptcy in the past, you may have a longer waiting period before you’re eligible for a new conventional loan.
  • You’ll pay for private mortgage insurance (PMI) unless you put 20% or more down. But you can send in a request to cancel your PMI once your loan balance is 78% of the original purchase price.
  • Down payment requirements, although potentially as low as 3%, are still high compared to VA loans. You can put 0% down for a VA loan in most cases.
  • Non-conforming conventional mortgages can feature especially tough qualification requirements. You might need a FICO Score of 700 or higher, a lower DTI, and a bigger down payment depending on the lender.

VA loans and how they work

The U.S. Department of Veterans Affairs (aka the VA) provides a home loan guarantee benefit that helps service members, veterans, and surviving spouses purchase homes.

These loans aren’t issued by the VA directly.

Instead, they come from private lenders like mortgage companies, banks, and credit unions. The loans, however, are guaranteed in part by the VA. Since 1944, the Department of Veterans Affairs has guaranteed more than 24 million VA loans for veterans and their families.

The VA Guaranty

When the VA guarantees a portion of your home loan, it agrees to pay back your lender some of the money you borrowed if you don’t follow through on your loan agreement.

In other words, if the lender has to foreclose on the property because you stop making your payments, the lender is partially protected.

This guaranty makes VA loans less risky for the lenders that issue them. As a result, you as the borrower may be able to lock in a better rate and financing terms if you’re eligible to use the VA benefit when you buy a home.

The basic entitlement for a VA loan is $36,000. That’s not the amount you can borrow to buy a home. Rather, it’s the maximum amount of money the VA promises to pay your lender in the event of a foreclosure (for loans under $144,000).

The actual size of your VA Guaranty can vary based on two factors:

  1. Your available entitlement
  2. How much money you borrow

Let’s take a closer look at each...

1 - The maximum guaranty is based on your available entitlement.

Your available entitlement comes down to whether you’ve had a VA mortgage in the past.

If you’ve used a portion of your VA loan benefit before, you may not be eligible for the full $36,000 entitlement — at least not until you sell that home and pay off your previous VA mortgage.

2 - How much money you borrow affects your VA Guaranty.

The VA guarantees loans under $144,000 for up to $36,000 if you have a full basic entitlement.

But if your home loan is higher than $144,000, the VA will promise to repay up to 25% of the loan amount in the event of a foreclosure.

On a $350,000 mortgage, a full VA Guaranty could potentially be worth up to $87,500 to a lender.

VA Certificate of Eligibility

Once you earn your VA loan benefit, you can use it over and over again throughout your life. There’s no expiration date and, contrary to myth, it’s not a one-and-done style benefit.

However, anytime you want to take out a new VA loan you’ll need to apply for a VA home loan Certificate of Eligibility (COE) early in the loan process.

When you submit your COE application, you must supply certain information along with it. For example, veterans need to provide copies of their discharge or separation documents.

If you’re an active-duty service member, on the other hand, you should include a signed statement of service with your personal details (e.g., name, Social Security number, date of birth, date you began active duty, etc.).

There are different requirements for:

  • Current and former members of the National Guard
  • Reserve members
  • Surviving spouses of veterans

You can learn more about how to apply for your individual VA home loan COE here.

You can request your Certificate of Eligibility from the Department of Veterans Affairs online. As an alternative, you might also opt to let your VA-approved lender do the legwork for you.

Either way, keep in mind that it might take as long as six weeks to receive your COE. So be sure to apply (or have your lender help you apply) for your COE sooner rather than later.

How to qualify for a VA loan

Once you have your Certificate of Eligibility, your next step will generally involve applying for a mortgage loan through a VA lender like a mortgage company or private bank.

To qualify for a VA home loan, you and the property you want to purchase will need to satisfy VA guidelines. VA borrowers need to meet individual lender requirements as well.

Some general VA loan requirements include:

  • No minimum credit score from the VA. Some lenders may require a FICO Score of 620 or higher.
  • No maximum debt-to-income ratio (DTI) set by the VA. However, lenders must provide “compensating factors” like liquid assets or excellent credit history if DTI is higher than 41%.
  • A VA appraisal of the property. The appraisal needs to verify that the property is “safe, sanitary, and sound.”
  • Loan limit of $510,400 or $765,600 in a few high-cost areas.

It’s also worth noting that a VA loan is only an option on a home that you plan to live in personally (aka a primary residence). But you can use the loan to buy a multi-family property of up to four units as long as you plan to make one of the units your primary residence, according to the VA.

If you want to buy an investment property that you will not live in yourself, you’ll need to consider a conventional mortgage loan or some other type of financing option.

Pros and cons of VA loans

Below you’ll find some common pros and cons of VA loans that can help you figure out if this loan option is a smart choice for you.

Pros:

  • You generally don’t have to provide a down payment to secure a VA loan. In fact, over 80% of VA loans are approved with zero down payment.
  • Closing costs tend to be lower. VA loans, unlike other types of mortgages, come with restrictions on the types of closing costs veterans can pay.
  • VA mortgage rates may be lower. Remember, there’s less risk for the lender with the federal government guaranteeing a portion of the money you borrow.
  • You don’t need private mortgage insurance (PMI) with a VA loan. This can potentially translate to a big savings over the life of your loan. On a conventional loan with a 5% down payment, PMI could cost you around an extra $150 per month on a $250,000 home loan.

Cons:

  • VA loans usually come with funding fees. Your funding fee may range between 1.4% to 3.60% of your total loan amount, according to USAA. That’s as high as $12,600 on a $350,000 loan. You can pay your funding fee at closing or finance it into your loan. However, if you have a service-related disability (and receive VA disability compensation as a result), you may be exempt. Surviving spouses of disabled veterans or of veterans who died during service may not have to pay the funding fee either.
  • VA loans come with extra qualification requirements. In addition to satisfying a lender, you need a Certificate of Eligibility plus the property will have to pass a special VA appraisal.
  • A previous foreclosure on a VA loan could make you ineligible to qualify for a new VA home loan in the future. But if you pay off the balance on that previous foreclosure, you may be able to recover your VA home loan benefit.
  • You might qualify for a loan that’s higher than the actual value of your home. With no down payment requirement, you can receive a loan that’s worth 100% of your home’s appraised value. When you tack on the funding fee and closing costs, you could end up owing more than your home is worth.

Conventional mortgage versus VA loan

Comparing conventional mortgages and VA loans side by side may help you determine if one of them is the right choice when you’re ready to buy a home.

Conventional Mortgage VA Loan
Eligibility Requirements Available to U.S. citizens and permanent resident aliens with a valid Social Security number Must be a current or retired service member or an eligible surviving spouse
Down Payment 3% minimum (20% to avoid PMI) No down payment required
Minimum Credit Score Needed 620 (Some lenders have higher minimum score requirements.) No minimum credit score per the VA (Your lender may have its own minimum requirement.)
Repayment Terms 30 years maximum 30 years maximum
Interest Rates Usually higher than VA loan rates Usually lower than interest rates on conventional mortgages
Fees Lender-specific fees like a loan origination charge VA loan funding fee plus lender-specific fees like a loan origination charge
Appraisal Requirements are less strict compared with VA loans Stricter appraisal requirements than conventional mortgages
Mortgage Insurance Requirements No PMI with a 20% down payment or cancel PMI in the future with 22% home equity No PMI requirement
2020 Loan Limits $510,400 to $765,600 (Jumbo loans may be available for higher loan amounts) $510,400 to $765,600 (Jumbo loans may be available for higher loan amounts)
Post-Bankruptcy Waiting Period 2-4 years (depending on type of bankruptcy) 1-2 years (depending on type of bankruptcy)
Post-Foreclosure Waiting Period 7 years 2 years (unless the foreclosure was on a previous VA home loan)
Investment Properties and Second Homes Financing available No financing available

How to determine which mortgage loan is right for you

The VA Loan Guaranty Service has helped millions of service members and their families purchase homes over the last 70+ years. And it’s clear that VA loans come with many benefits that aren’t available to the general public.

As a service member, veteran, or surviving spouse, it’s wise to explore this financing option if you’re eligible for a VA mortgage loan.

Just keep in mind that VA loans aren’t the right choice 100% of the time.

No two borrowers are the same. It’s important to consider all of your loan options before you pick the mortgage type that’s right for you.

When a VA loan might not make sense

Here are 4 examples of when a conventional mortgage loan could make more sense.

Example 1 - When you want to put 20% down on your home loan and you have good credit, a conventional loan might save you money.

With a 20% or higher down payment on a conventional loan, you can avoid the VA Funding Fee and the additional costs of PMI. You might be able to secure a better interest rate in this situation as well.

Example 2 - If you want to refinance and cash out some of your home equity, a conventional loan might put more money in your pocket.

With a VA refinance, the Funding Fee will cut into how much equity you can cash out. As a bonus, refinancing a VA loan to a conventional mortgage will also reset your VA entitlement for future home loans.

Example 3 - A VA loan might not be ideal if you’re buying a home that needs major repairs or remodeling.

VA loans require the home you’re buying to be in relatively good shape when you finance it. Otherwise, the property might not pass a VA appraisal.

Example 4 - When you’re buying a property that you don’t plan to live in for a while, a VA loan might not work for you.

You have to move into your home within 60 days or less if you use a VA loan to purchase it.

Next steps

No matter which type of mortgage you ultimately choose, it’s critical to check your three credit reports from Equifax, TransUnion, and Experian before you start filling out loan applications.

Review your reports for errors and, if you find any, be sure to dispute them with the appropriate credit reporting agency.

Mistakes on your credit report matter because they could lower your credit scores and may potentially cause serious problems during the home buying process.

It can also be helpful to look for ways to build or rebuild your credit before you apply for a mortgage. Your credit rating, after all, can have a major impact on the cost of your home loan.

Once your research is complete and your credit is in the best shape possible, you may be ready to start shopping for mortgage lenders.

It’s important to compare loan offers from multiple lenders to make sure you’re getting the best deal available for your situation. Pricing and fees can vary widely. Taking the time to shop for a mortgage and negotiating with lenders could possibly help you save thousands of dollars or more in the long run, according to the FTC.

About the author

Michelle L. Black is a leading credit expert with over 17 years of experience in the credit industry. She’s an expert on credit reporting, credit scoring, identity theft, budgeting and debt eradication.

Written on October 6, 2020

Self is a venture-backed startup that helps people build credit and savings.
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Disclaimer: Self is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.

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