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Buying a home can be a long, stressful, and expensive undertaking, but home buyers may be able to expedite this process while minimizing stress and keeping out-of-pocket costs manageable by choosing the right loan type.
Whether a home buyer is looking to originate a new loan or refinance, FHA loans and VA loans can both be great options to consider. But as buyers embark on the journey of homeownership, understanding the key differences between FHA and VA mortgages will be crucial to selecting the best loan type for their unique needs. To help, this article breaks down the basic features of these loan types, with both FHA and VA loans explained comprehensively to equip borrowers with the information they need to understand the differences between an FHA vs. VA loan.
1. Both FHA and VA loans are backed by the federal government, which means both are able to offer more flexible financing terms than conventional mortgages.
When choosing a mortgage lender, it’s important for shoppers to consider eligibility requirements. Because conventional mortgages are backed and originated by private lenders, these loans typically come with stricter financing terms, including more stringent down payment, credit score, and debt-to-income (DTI) requirements. As such, not all home buyers will be able to qualify for a conventional mortgage.
FHA and VA loans, on the other hand, are secured by the federal government. This financial backing protects the lender in the event that the homeowner defaults on their mortgage, encouraging lenders to be more lenient in their terms and approving loans for borrowers with lower credit scores, lower down payments, and so on. For this reason, homeowners who are concerned about qualifying for a conventional mortgage may want to consider an FHA or VA loan.
2. VA loans are only available to active and former military members as well as surviving spouses, while FHA loans often appeal to first-time home buyers or borrowers who are unable to qualify for a conventional mortgage.
When comparing the different types of home loans on the market, prospective home buyers need to be aware that VA stands for Veterans Affairs, and as such, VA loans are only available for eligible veterans, active-duty or former service members, and surviving spouses. VA loans are guaranteed by the U.S. Department of Veterans Affairs.
While active and former service members may benefit from a VA loan, first-time home buyers without military affiliations may instead want to consider an FHA loan. These loans, backed by the Federal Housing Administration (FHA), can offer flexible terms for homeowners who are unable to qualify for a conventional mortgage. As such, FHA loans may be ideal for those interested in getting financing through one of the best mortgage lenders for first-time buyers.
3. Although FHA loans have low down payment requirements relative to conventional mortgages, borrowers with VA loans won’t be required to make a down payment at all.
Though most conventional mortgages require a 3 percent down payment at minimum (though borrowers who put down 20 percent of the purchase price can bypass private mortgage insurance), home buyers may be able to limit the up-front costs of homeownership by considering other loan types. With an FHA loan, down payment percentages as low as 3.5 percent of the purchase price may be sufficient for buyers with credit scores of 580 or higher.
However, this may not be the case in circumstances where the buyer has a personal relationship with the seller. The Federal Housing Administration calls this an FHA identity of interest, and it can refer to any familial or business relationship—if a son or daughter buys their parents’ house, for instance. In this type of transaction, home buyers will want to note that the FHA may require a down payment as high as 15 percent of the purchase price.
Borrowers looking to get a VA loan may be happy to learn that they will not be required to pay a down payment at all. This means that although obtaining this form of financing may require a few extra steps, such as providing a statement of service, VA loans can make it easier for borrowers who qualify to turn their dream of homeownership into a reality.
4. FHA credit score requirements often depend on the size of the down payment, whereas VA loans have no minimum criteria—but the lender will have the final say either way.
Unlike conventional loans, which may require eligible borrowers to have a credit score of at least 620, the minimum credit score required for an FHA loan can be much lower, depending on the size of the down payment. With FHA loans, credit scores as low as 500 may be acceptable, though borrowers with scores below 580 will be required to pay a larger down payment—as much as 10 percent of the property’s purchase price. With that in mind, FHA loans may be a good option for home buyers looking to get a home loan with bad credit.
Meanwhile, there is no minimum credit score requirement for VA loan approval. However, it’s important to note that both FHA and VA mortgage guidelines may vary between lenders, so although these loan types can make it easier for borrowers to obtain financing, specific credit score requirements will depend on the mortgage lender.
5. Borrowers with FHA loans will pay a mortgage insurance premium (MIP) every month for the entire loan term, while those with VA loans will owe an up-front funding fee.
With an FHA loan, borrowers will be required to pay up-front and ongoing fees to protect the lender in case they default on their mortgage payments. Due to this loan type’s low down payment requirements, home buyers will need to pay an up-front mortgage insurance premium (MIP)—sometimes referred to as an FHA funding fee—equal to 1.75 percent of the base loan amount to secure financing. It’s worth noting that this cost is in addition to the borrower’s down payment.
FHA buyers will also be required to pay MIP every month throughout the life of the loan, though the exact cost of this premium will depend on several factors, including the loan-to-value (LTV) ratio, the size of the down payment, and the length of the mortgage term. LTV ratios compare the size of the requested loan with the value of the home. Lenders typically view mortgages with higher LTV ratios as riskier investments since the borrower has less equity in the property from the outset and may be more likely to default on their loan. Borrowers are often required to pay mortgage insurance to help offset that risk.
Jason Bower, vice president of lending for Epic Mortgage, located in Brookfield, Wisconsin, explains that although MIP on an FHA loan can be minimized with a large enough down payment, insurance premiums will always be required for some portion of the loan term. “FHA loans require mortgage insurance for the life of the loan unless you put 10 percent down, and then it is [only required for the first] 11 years,” he says. “For a VA loan, there is no mortgage insurance required for the loan.”
Although VA loan borrowers won’t need to worry about mortgage insurance payments, they will be required to pay a one-time VA funding fee, which varies depending on the size of the down payment and whether they have used their VA entitlement before. Funding fees can range between 1.25 percent and 2.15 percent of the loan amount for a first home and from 1.25 percent to 3.3 percent for any subsequent loans.
6. Whereas VA loans often require debt-to-income (DTI) ratios below 42 percent, FHA lenders tend to be more lenient, allowing for DTI ratios up to 50 percent in some cases.
Prospective home buyers will need to meet certain debt-to-income (DTI) requirements to get a mortgage, whether it’s a conventional, FHA, VA, or other type of loan. Lenders consider DTI ratios to understand how much of a borrower’s gross monthly income is spent on recurring debt payments, including the estimated monthly mortgage payment.
In some cases, borrowers may be able to qualify for an FHA loan with a DTI ratio as high as 50 percent. But unlike FHA loan requirements, VA loans typically require borrowers to have DTI ratios below 42 percent to qualify. To determine whether they meet these requirements, prospective home buyers can calculate their debt-to-income ratio by dividing their total monthly debts by their monthly income before taxes.
7. FHA interest rates tend to be slightly higher than VA loan rates—and APRs on FHA loans are often even higher due to mortgage insurance.
The mortgage rate on a home loan represents the interest home buyers will have to pay to borrow money from their lender. When borrowers are comparing interest rates, VA loans tend to win the race for the best options, with the interest rate for a VA home loan often sitting lower than that of an FHA loan.
The annual percentage rate (APR) on an FHA loan is often higher than that of a VA loan due to the added cost of mortgage insurance. However, both FHA and VA loans tend to offer slightly lower rates than conventional loans. It’s also important to note that interest rates will also depend on the borrower’s household income, credit score, and DTI ratio, among other factors.
8. While VA mortgages have no federal loan limits for borrowers who still have their full entitlement, FHA loan limits vary by county and the size of the property.
Both conventional and FHA loans limit the amount home buyers can borrow, with maximum loan limits depending on both the location and the size of the property. Meanwhile, many VA loan borrowers won’t need to worry about loan limits at all, as only borrowers with one or more active VA loans, or those who have previously defaulted on a VA loan, will be subject to them.
This is because VA loan limits are dependent on the borrower’s VA entitlement amount, which refers to the total amount the Department of Veterans Affairs is willing to repay if the borrower defaults on their loan. Borrowers who have never received a VA loan before or who have fully repaid a previous VA loan have their full VA entitlement—in which case they are not subject to any loan limits. Those with an existing VA loan, on the other hand, have already tapped into this entitlement amount, so although the VA will back subsequent loans to an extent, there are certain limits in place, which mirror conforming loan limits for conventional mortgages. First-time home buyers with a basic entitlement or bonus entitlement (the additional amount the VA will guarantee if the loan amount exceeds $144,000) will not be restricted by these limits, though.
9. Deciding which financing option is better often comes down to a person’s military status: Active and former service members will benefit more from the lower rates and flexible down payment options that VA loans offer.
When applying for a mortgage, potential home buyers have several loan types to consider. But in the case of FHA vs. VA loans, the decision may be made simpler by the fact that only active and former service members, as well as surviving spouses, can qualify for the VA loan program.
Borrowers who meet these eligibility requirements may be able to benefit from the lower rates and flexible down payment options VA loans can provide. It’s possible for them to pursue a loan from one of the best VA mortgage lenders such as Veterans United or Navy Federal Credit Union. On the flip side, borrowers who do not qualify for a VA loan may be able to reap the reward of similar benefits by going with an FHA loan. Although FHA rates may be somewhat higher than VA loan rates, and the borrower will be required to make a down payment, FHA loans can still be very appealing to first-time home buyers who may not qualify for a conventional mortgage. The best FHA lenders may be able to help those with low credit scores, high DTI ratios, and low funds for a down payment realize their dream of homeownership.