VA Interest Rates Vs. Conventional: Which Is Lower?
When you’re buying a house, it makes sense to explore all of your finance options before making a decision to move forward. There are a variety of loans available, including conventional, VA, and more. Each type of loan will have different interest rates, along with other variables that you’ll need to consider.
As a general rule, VA interest rates are lower than those of conventional loans. The difference between them can be anywhere from 1-4%, depending on things such as:
- Credit score
- The housing market at the time of origination
Consider all aspects of the loan: not just the interest rates.
A VA-insured loan will often have other terms and conditions that many home buyers aren’t aware of. Being educated on these conditions is important before deciding which one to use. Keep reading; here, we will explore the differences between conventional loans and VA loans and discuss why one might be better than the other at any given time.
VA Interest Rates Are Lower Than Conventional Loans
On average, VA interest rates are much lower than conventional loans and have been for a number of years, according to Ellie Mae. These loans are backed by the Department of Veteran’s affairs, which acts as an insurance plan against defaulted mortgages. Since a VA loan has its own built-in insurance plan, lenders feel more comfortable extending more favorable terms to the borrower.
Lenders base their interest rates and other financing terms on things such as credit scores and market conditions.
Generally, the higher your credit score, the more favorable your interest rates will be. However, veterans enjoy lower rates as part of a basic entitlement for serving their country for a period of time.
VA Loans Don’t Require a Down Payment
The vast majority of VA loans do not require a down payment, making them an attractive offer for many veterans. On the other hand, almost all conventional loans require a down payment, but the percentage of that payment has steadily declined. Many lenders have historically required a down payment of 20% of the purchase price, but you can find a conventional loan with as little as 3% down if you do some digging.
Beware of what sounds too good to be true, though. Not paying a down payment can sound like a fantastic way to purchase a home, but it comes with some other qualities that may not be favorable for your situation. The lack of a down payment can affect a variety of other issues on your loan, including the monthly payment amount.
There is No Mortgage Insurance on a VA Loan
If you’ve done any research into conventional home loans, you’ve probably heard the term “private mortgage insurance,” or PMI. This is a fee that is added to your mortgage payment on a conventional loan when you put less than 20% down. Although many lenders offer programs that don’t require a down payment, they get you on the backend with PMI.
Conversely, VA loans do not require any mortgage insurance, regardless of whether or not you put any money down. As referenced earlier, this is because the loans are backed by the government. Since these loans have their own “insurance” plan through the Department of Veteran’s affairs, there is no need to assess PMI on the payments.
VA Loans Don’t Require a Minimum Credit Score
Most lenders base your rates and mortgage terms on your credit score. Although many will claim that there is “no minimum credit score,” that’s too good to be true most of the time. The VA states that there is no minimum credit score for Veterans to purchase homes, but there’s a catch.
Although the VA does not require a minimum score, most lenders do. So although you may be able to get the VA to back your loan, regardless of your score, you’re not likely to be approved for the loan without a score of at least 620-640. If your credit score is lower than that, you may want to consider an FHA loan.
VA Loans Require Primary Residency
One of the major differences between VA loans and conventional ones is the residency clause.
With a VA loan, there is a requirement that the property is your primary residence. This means that it must be your place of residence for the majority of the calendar year, with the exception of deployments and other military activities.
Conventional loans, on the other hand, are valid for all types of property purchases. These loans are used for:
- Primary homes
- Second homes
- Even investment properties
The terms are often stricter in the case of a second home or an investment property because the bank is taking a higher risk that the borrower will be able to pay not only this mortgage but their first mortgage, as well.
VA Loans Have Higher Fees Than Conventional
Although a VA loan can be very attractive for many veterans, it’s not bullet-proof. One of the big drawbacks of a VA loan is a fee called the “funding fee.” This fee was designed to help the VA protect themselves against defaults on various loans that they insure.
The funding fee can vary from 1.4-3.6% of the total amount of the loan, depending on factors such as your down payment amount and your credit score. (Although the VA does not require a down payment, many veterans still put money down in order to decrease their monthly payment). The fee is required to be paid upfront and is often rolled into the mortgage so that the down payment amount is truly $0.
The problem with rolling this fee into the mortgage is that the borrower will end up paying more in the long run. If the buyer doesn’t have the cash to pay this fee upfront, they will have to pay it in payments over the life of the loan, which is generally 30 years. When you assess the interest rate of the loan to this fee over time, the borrower could end up paying thousands more than the fee itself.
VA Loans Have Debt-to-Income Requirements
Just like conventional loans, the VA requires that your debt to income ratio is within a certain set of standards. Although these loans are often advertised in a way that makes you believe there are no criteria for debt to income ratios, that’s simply not the case.
If your loan brings your ratio to 41% or higher, the VA will require “compensating factors” from the lender who approved your loan.
What does all this mean? It means that your debt to income ratio is still an important factor with a VA loan. Conventional loans have standards around this issue, and so do VA loans.
How do I Choose a VA Loan Vs. Conventional?
Based on all of the factors listed above, you should be able to make a great financial decision before purchasing your home. There is no right or wrong answer in this instance. There are so many factors affecting this decision that you’ll need to compare and contrast them in order to choose.
Here’s a simple table to help you evaluate the differences between the two types of loans:
| FACTOR | VA LOAN | CONVENTIONAL LOAN |
| Interest Rates | Generally lower than conventional | Standard rates based on the market at the time of origination |
| Down Payment | $0 | 3% – 20% of purchase price |
| Mortgage Insurance | None required | Required if the down payment is less than 20% |
| Minimum Credit Score | None required by the VA but may be required by a lender | Almost always required by a lender, and usually a minimum of 640 |
| Residency | Must be the primary residence | Can be a primary residence, second home, investment property, or other |
| Fees | VA Funding fee of 1.4% – 3.6% of the total amount of the loan | Standard fees associated with mortgages |
| Debt-to-Income Ratio | 41% or less | 36% or less |
Is it Smart Not to Pay a Down Payment?
The decision to make a down payment on a home or not depends on your specific financial situation at the time that you purchase your home. It can also vary based on the type of loan you’re getting or hoping to get. As we discussed earlier, a down payment is not required on a VA loan but could still be a good idea if you’re trying to minimize your monthly expenses.
With a conventional loan, the amount of your down payment could significantly affect your interest rate and your monthly payment. If your down payment is less than 20%, most lenders will assess PMI to your monthly payment, which will often range from $150-250 per month. This is a substantial amount of money for many homeowners.
VA loans do not require any down payment or mortgage insurance, which makes them incredibly attractive to many buyers. However, your monthly payment will still be higher if you choose not to put any money down. This is due to two key factors:
- The total amount of the loan is higher, so you’re dividing a higher amount into payments over30 years
- The higher total amount of the loan results in a higher VA funding fee, which is often assessed over the life of the loan and added to your monthly payment
For many people, making a down payment on a house makes more sense financially than not doing so. However, many homebuyers do not have the available cash to purchase a home, which is why VA loans are a great option for many veterans. In the end, only you will know whether you need the cash in the bank or against the loan amount.
Why Don’t More Veterans Use VA Loans?
Although the use of VA loans has increased in the past several decades, they are still not being utilized as often as they could be. There are a number of reasons for which this could be the case. For example, it’s possible that veterans are unaware of this benefit or feel as though homeownership is out of reach.
Polls conducted on veterans regarding VA loans have shown a variety of reasons for which they aren’t being used. Below are a few of the reasons for which veterans say they have not taken advantage of this benefit. Some of the responses may surprise you:
- Some veterans have a perception that VA loans are inferior to conventional and other loan programs
- Many lenders steer veterans towards other products that are more profitable for the bank
- Veterans often say they don’t know about the VA loan program
- Some real estate professionals say that their clients don’t want to wait around for the VA to approve their loan, so they opt for other programs
Are VA Loans More Expensive Than Conventional?
VA loans are sometimes less expensive and sometimes more expensive than conventional loans. Each deal is different, and every situation is unique. While the VA loan program offers a ton of perks to their veterans, it is still possible for a VA loan to be more expensive over time than a conventional loan.
To be sure that you’re getting the best deal, you need to consider all of the factors and do some simple math. The chances are you’re doing pretty well if you’re getting a loan with:
- Zero down payment
- Lower interest rates
- No mortgage insurance
However, factor in the VA funding fee and make sure you know how much that will add to your loan.
This factor alone tends to be the deciding point between which mortgage is more expensive. It’s smart to do all the numbers before signing on the bottom line. You can also get estimates from more than one lender to find the best deal for you and your family.
Conclusion
If you’re in the market for a home loan and you’re a veteran, be sure to weigh all the options. The VA loan program is designed specifically to help veterans purchase a home with minimal upfront costs.
However, if you have some money in the bank and can pay a down payment or have a stellar credit score, you may be better off with a conventional loan. As we mentioned before, every situation is different, so the best thing to do is do your due diligence!
Additionally, Active Duty Passive Income offers an awesome in-house lending team that can help you with any of your VA Loan or Conventional Lending needs. Connect with a loan officer to find out more!
Sources:
https://www.nerdwallet.com/article/mortgages/va-loans-vs-conventional-loans
https://www.usaa.com/inet/wc/advice-real-estate-is-va-loan-way-to-go?akredirect=true
