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When it’s time to buy a home, the type of mortgage you choose is important. But with so many options, how do you know whether to apply for a conventional loan or a mortgage guaranteed by the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA)?
Each mortgage product has its own advantages and disadvantages depending on your financial profile and the type of home you want to buy. We’ll walk you through the differences between these types of loans to help you decide which one is the best you can qualify for and save the most money over time.
Comparison of conventional, FHA and VA loans
There are several types of loans available to home buyers. but the most common are: conventional, FHA and VA loans. They all operate a little differently and have different qualification requirements.
What is a conventional loan?
The most common type of mortgage, conventional loans, are created and managed by private banks, credit unions, and other financial institutions. They are not supported by any government agency.
However, many conventional mortgages are considered âcompliantâ loans, meaning they comply with loan limits set by the Federal Housing Finance Agency (FHFA). They also meet certain standards put in place by government-funded companies known as Fannie Mae and Freddie Mac, who buy and guarantee these loans and then sell them as mortgage-backed securities to investors.
Conventional loans that do not meet these guidelines are called non-conforming loans. This can include loans that exceed the limits set by the FHFA (called jumbo loans) or that have more flexible credit score requirements (called subprime loans).
What is an FHA loan?
An FHA loan is a type of mortgage guaranteed by the Federal Housing Administration (FHA). The FHA does not actually fund these mortgages. Rather, it insures loans made by individual lenders approved by the FHA so that they are financially protected in the event the borrower defaults.
These loans are designed for potential homeowners who would not otherwise qualify for an affordable conventional loan, especially first-time home buyers, and offer more flexible down payment and credit score requirements. They can only be used to finance primary residences, not investment or vacation properties.
What is a VA loan?
Similar to FHA loans, VA loans are government guaranteed mortgages that are partially guaranteed by the United States Department of Veterans Affairs (VA). They are issued by independent financial institutions, which are able to offer more advantageous conditions since the VA guarantees part of the funds.
VA loans are specially designed to help eligible military, veterans and surviving spouses become homeowners. They can be used to purchase a property as a primary residence or to refinance an existing mortgage.
Which loan is right for you?
If you are thinking about buying a home in the near future, you may be wondering which type of mortgage is the most suitable. Whether you opt for an agreement, an FHA or VA loan will depend on a few factors related to your financial situation.
The deposit plays a role
One thing to consider is how much money you can afford to save for a down payment. Here’s a more in-depth look at the down payment requirements for each type of loan.
- Conventional loan: It is possible to take out a classic loan with only 3% down payment. However, if you put in an amount less than 20%, you will have to pay for private mortgage insurance (PMI) until you reach a loan-to-value ratio (LTV) of 80%. PMI is calculated as a percentage of your total loan amount and ranges from 0.58% to 1.86%.
- FHA loan: Unlike conventional loans, you are required to pay FHA mortgage insurance regardless of your down payment. However, if you deposit at least 10%, you can give up home loan insurance after 11 years of payments, otherwise it stays that way for the life of the loan. FHA mortgage insurance requires an initial premium payment of 1.75% of the loan amount, followed by annual payments of 0.45% to 1.05% of the loan amount, depending on certain factors.
- VA loan: Unlike conventional and FHA loans, VA loans do not require any down payment. They also don’t require mortgage insurance, but come with a one-time financing fee of 1.25% to 3.3% of the loan amount.
Debt to income
Your debt-to-income ratio (DTI) measures how much of your monthly gross income is spent on debt repayment. Most mortgage lenders have maximum DTI requirements, but these requirements vary depending on your type of loan.
- Conventional loan: Most lenders will require a back-end DTI (your potential mortgage payment, plus all of your other debt payments, relative to monthly income) of no more than 45%. If you have excellent credit or a large down payment, your lender may allow an DTI of up to 50%.
- FHA loan: The maximum DTI allowed for FHA loans is 57% if you have a credit score of at least 580. For borrowers with lower scores, the maximum DTI allowed by most lenders is 43%.
- VA loan: The acceptable DTI limit for most VA loans is 41%. However, it is possible to qualify for a VA loan with a DTI of up to 60%, although you will be subject to a more extensive underwriting.
Aside from the down payment and the DTI, your credit score will also play a role in whether it is best to apply for a conventional, FHA, or VA loan. Here are more details on the credit score requirements for these loans.
- Conventional loan: Lenders typically require a minimum credit score of 620 to qualify for a conventional loan, although some may prefer a score of at least 660. Ultimately, the credit score requirements depend on the individual lender. The higher your credit score, the better the interest rates and loan terms you will receive.
- FHA loan: The minimum credit score requirement for an FHA loan depends on the size of your down payment. You can take out an FHA loan with a credit score as low as 580 if you put at least 3.5% down, or a score as low as 500 with at least 10% down.
- VA loan: If your credit is not in good condition, the good news is that VA loans do not have a minimum credit score requirement to qualify. However, individual lenders may have their own credit score references which must be met to be approved.
Below is a simple breakdown of how these types of loans stack up:
Now that you know the basics of how conventional, FHA, and VA loans work, it’s time to determine which one best suits your needs.
Speak with your lender
Your potential lender is a good place to start. Many lenders are approved to provide several types of loans, including conventional mortgages and government guaranteed mortgages such as FHA and VA loans. Discuss your options and see what’s available.
Compare rates and costs
Remember, it’s not just about getting approved or getting a low monthly payment. You also need to calculate the numbers and figure out how much a certain loan will cost you over the lifetime. It means comparing factors like interest rate, mortgage insurance, closing costs and more. It’s a good idea to get quotes from multiple lenders so you can compare rates and fees to find the best deal available based on your financial situation.