Conventional Vs. VA Mortgage

Choosing the mortgage that best suits your needs is a little like shopping for clothes and trying to find the “right fit.” If you’re currently or formerly a member of the military, you’re eligible for a VA mortgage, but your options still include a conventional mortgage. The short list of benefits for a VA home loan versus a conventional mortgage includes no down payment and no mortgage insurance in the “plus” column for the VA loan. But conventional mortgages have some attractive benefits in their “plus” column, too, which is why it may be time to go “comparison shopping” for your new mortgage.

Overview of Conventional Home Loans

Conventional home loans are mortgages offered by lenders that are not insured or guaranteed by government agencies such as the Department of Veterans Affairs (VA) and the Federal Housing Administration (FHA). Some conventional home loans are classified as “conforming” mortgages because their mortgage underwriting guidelines must conform to Freddie Mac and Fannie Mae requirements. Although Freddie and Fannie are secondary mortgage market entities known as government-sponsored enterprises (GSEs) that finance mortgages from originating lenders, neither Freddie nor Fannie actually provide loans to borrowers.

Overview of VA Home Loans

The U.S. Department of Veterans Affairs, which helps mitigate VA loan problems for sellers, backs VA home loans. VA loans are designed to assist veterans, members of the military and other borrowers with certain military affiliations. The VA does not originate home loans, nor does it fund the loans – it simply guarantees a portion of the loan against loss to the lender who extends the mortgage.

VA lenders include eligible private mortgage companies, savings and loan institutions, banks and credit unions. VA loan pros and cons are different for each borrower, but an overriding feature is that the loans are specifically tailored to help ease the housing financial burden for military and military-affiliated members.

Different Loan Types

Conventional. Types of conventional mortgages include conforming, non-conforming, jumbo and portfolio loans. Conforming loans must conform to Freddie Mac and Fannie Mae guidelines, but some conventional loans are non-conforming, which means that they don’t fit into these guidelines. Non-conforming mortgages with larger loan limits than Freddie and Fannie allow are called jumbo mortgages. Portfolio mortgages are non-conforming loans that lenders hold without selling to investors, which allows the portfolio lender latitude to set its own qualifying guidelines.

VA. Types of VA loans include home-purchase loans, cash-out refinance loans and interest rate reduction refinance loans (IRRRLs). When a borrower builds up sufficient equity in a property, the cash-out refinance mortgage offers the option to refinance the existing VA mortgage and receive cash for a portion of the equity. An IRRRL, also called a streamline refinance, allows the mortgagor of an existing VA loan to refinance the mortgage at a lower interest rate.

Borrower Mortgage Profiles

Conventional mortgages. Borrowers who have good and established credit scores, a debt-to-income ratio (DTI) of no more than 43 percent and a down payment of 20 percent are the most likely candidates for a conventional mortgage. Lenders also look for borrower candidates who do not have bankruptcies or foreclosures during the seven years prior to applying for a conventional mortgage.

VA mortgages. Borrowers who are eligible for VA loans include veterans, members of the military on active duty, reservists, members of the National Guard, surviving spouses of veterans, officers at the National Oceanic and Atmospheric Administration, midshipmen at the U.S. Naval Academy and cadets at the U.S. Military, Air Force or Coast Guard Academy. Generally, service members must have served 181 days of active duty during peacetime, 90 days of active duty during wartime or six years in the National Guard or Reserves. An eligible surviving spouse is typically someone who has not remarried after their military spouse was killed in the line of duty.

VA Certificate of Eligibility

VA-eligible borrowers must demonstrate their eligibility by providing a Certificate of Eligibility (COE) to a VA mortgage lender. All VA-approved lenders can facilitate this by ordering a COE online through the VA’s Automated Certified of Eligibility (ACE) system or its automated Web LGY. One exception is the IRRRL, which does not require a COE. Note that simply having a COE is not a guarantee of VA loan approval; it only means that you are eligible to apply for a VA loan.

Mortgage Loan Limits

Conventional. Across most of the continental United States, a conforming conventional mortgage cannot exceed $484,350 (as of 2019). This limit is established by the Federal Housing and Finance Agency (FHFA) to meet Freddie Mac and Fannie Mae underwriting guidelines. A jumbo loan of $600,000, for example, does not meet this loan limit, but it can be classified as a non-conforming conventional loan if it otherwise meets conventional loan criteria.

VA. VA mortgage limits are established on a county-by-county basis. As of 2019, the maximum VA-guaranteed mortgage limit in most U.S. counties is also $484,350. In some counties, higher VA-guaranteed loan limits may reach up to $726,525. Some Hawaii locations may have loan limits that exceed $726,525.

Qualifying Property Types

Conventional. In addition to purchasing a borrower’s primary residence, a conventional mortgage may also be used to finance second homes and investment properties.

VA. A borrower can use a VA loan to purchase a primary residence only. VA loans are not available to purchase second homes or investment properties. An exception is for borrowers who have rental homes that they formerly occupied as a primary residence. These borrowers can use a VA loan to refinance the property. VA loans are also available to borrowers who live in one unit of a duplex, triplex or four-unit apartment building.

Down Payment Requirements

Conventional. The rule of thumb for a down payment on a conventional mortgage is 20 percent of the home’s purchase price. A lender may accept less than this but will likely require the borrower to pay private mortgage insurance (PMI) premiums until the home equity reaches 20 percent. During the loan qualifying process, borrowers generally must produce bank statements or investment account statements that verify the availability of funds for the down payment. If a borrower’s down payment comes from a cash gift, the borrower will have to produce a notarized “gift letter” that confirms the funds truly are a gift and not a loan.

VA. One of the most appealing features of the VA loan is the no-down-payment requirement, which allows borrowers to finance 100 percent of a home’s purchase price.

Mortgage Insurance Requirements

Conventional. As long as borrowers make at least a 20 percent down payment, they typically won’t have to purchase mortgage insurance. If lenders accept a down payment of less than 20 percent, the tradeoff is that the borrower likely has to pay mortgage insurance premiums until the home equity reaches 20 percent.

VA. Even with the no-down-payment benefit of a VA loan, VA mortgages also have no mortgage insurance requirement.

Credit Scores Needed to Qualify

Conventional. Lenders of conventional loans look for credit scores that are at least 680. Scores of 700 and higher are preferred, and borrowers who have scores greater than 740 will get the best interest rates.

VA. Although the VA does not require a minimum credit score, VA-qualified lenders generally look for scores that are at least 620. It’s possible to find a lender that will approve a VA loan with a lower credit score, but you may have to shop around to find one. Borrowers who file for a Chapter 7 bankruptcy or who have had a foreclosure must wait two years before applying for a VA loan. Borrowers who are currently in Chapter 13 bankruptcy must prove they’ve made at least 12 timely payments and obtain the bankruptcy court’s approval.

Debt-to-Income Ratio Guidelines

A borrower’s monthly debt load compared to the borrower’s monthly income is called the debt-to-income ratio (DTI). "Debt" includes costs such as loans and credit card payments, but it doesn't include monthly expenses such as utilities, groceries and gas. Expressed as a percentage, the DTI loan requirement varies, depending on loan type and lender. As an example of DTI, if your gross monthly income is $5,000 and your monthly debt payments total $2,000, your DTI is 40 percent [2,000/5,000 x 100 (to convert to a percentage)].

Conventional. As of July 2019, Fannie Mae increased its DTI requirement to 50 percent, which was an increase of 5 percent over the former 45-percent requirement.

VA. The DTI guidelines for VA loans don’t specify a maximum DTI, but if the DTI exceeds 41 percent, a lender must justify the amount by providing compensating factors.

Debt-to-Income Compensating Factors

The maximum DTI may be higher or lower, depending on certain factors that vary from borrower to borrower.

Conventional. If a borrower has a high credit score, a large down payment or a substantial balance of cash reserves left over after making a down payment, a lender may approve a higher DTI. On the flip side, Fannie Mae maximum DTI guidelines may be lower in other circumstances, including cash-out refinances and high loan-to-value refinances.

VA. If the automated calculation of DTI results in a low residual income – the money that you have left at the end of each month after paying bills – you can request a manual calculation. Sometimes a high DTI doesn't necessarily reflect your "true" living costs because, for example, of the geographical area where you live. VA residual income guidelines vary among four regions: Northeast ($1,025), Midwest ($1,003), South ($1,003) and West ($1,157).

The Mortgage Reports offers an example of how residual income may be a compensating factor when a borrower has a high DTI. Consider a borrower who has a monthly income of $5,000 and total monthly debts of $2,500 plus other monthly bills of $1,280. The borrower’s DTI is 50 percent ($2,500/$5,000 x 100), but his residual income is $1,220 ($5,000 minus $3,780).

The maximum VA residual income requirement across all of the four income regions is $1,157, which is less than the borrower’s residual income. So although the borrower’s DTI exceeds VA’s recommended guidelines, the compensating factor of a higher residual income may allow VA loan approval.

Mortgage Loan Fees

All mortgage loans have fees attached, but these fees vary depending on the type of loan, the lender and state tax laws.

Conventional. A rule of thumb for calculating fees on a conventional mortgage is 3 percent to 6 percent of the home’s purchase price. If your mortgage is $200,000, for example, you’ll pay from $6,000 to $12,000 in closing fees.

VA. VA mortgages have a “funding fee,” which is a cost the borrower pays upfront. The amount of the funding fee is based on certain factors such as the amount of the borrower’s down payment and the loan amount. Even though it’s considered an “upfront” cost, borrowers do not have to come up with the cash at closing to cover this fee. The VA allows borrowers to finance the funding fee, which ranges from 1.25 to 3.3 percent of the home's purchase price with the mortgage loan.

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