FHA vs VA vs USDA Loans
When you are preparing to buy a home, deciding which mortgage is right for you is important. Though you can go for a conventional home loan, perhaps one of the government-insured programs will better suit your situation.
The FHA, VA, and USDA offer loan programs that may make it easier for many families to buy property.
But which is right for you?
We look at the three main government loan programs to help you pick the right program for your situation.
How Do You Choose Between FHA, VA, and USDA Loans?
These government-insured loans are not necessarily suitable for everyone, but you might find that one of these programs is your best option when getting a home loan.
Since the federal government is insuring loans made through these programs, it allows lenders to offer money to borrowers they wouldn’t normally accept. This means that you might not need as good a credit score or history, and you won’t need to save as much money for a down payment in most cases.
Keep in mind that down payments differ from earnest money. Earnest money is required for most home purchases and is held in escrow until closing.
To choose between these loan types, you need to first see which ones you qualify for, as it’s unlikely you will qualify for all of them.
When you choose an FHA loan, the government insures the loan. This allows lenders to offer loans to people that may not qualify for conventional mortgages, while still offering attractive terms.
An FHA loan does require a steady income and stable payment history over the past 2 years. If you meet these criteria, you might qualify for a loan that would otherwise not be available through conventional mortgages.
Credit score minimums
If you don’t have the best credit, you will be more likely to qualify for an FHA loan over a conventional mortgage. If your credit score is only average or not even that good, you could still qualify for an FHA loan.
While the lender will set their minimums, these are generally lower than conventional mortgages.
FHA rules mean that you can pay as little as 3.5% as a down payment.
If you are a first-time borrower, it is common to get help from family members, and the FHA allows for this. If a family member or even a close friend donates money to meet the down payment requirement, a gift letter needs to be written, and bank statements may be required. The borrower also needs to leave the money in their account after they have deposited it, until closing.
The money for the down payment can also come from savings, or withdrawn from 401Ks and IRAs. Though if you have someone willing to give you the money, it will make buying a house easier as you won’t have to spend years saving for the down payment.
An FHA loan can offer you more options over other loan types. You can use this type of loan to buy a duplex where you are living in one of the units and renting out the others. You can also use this loan to buy a condo, though it does have more requirements compared to a single family home purchase.
You can streamline refinance or cash out equity through an FHA loan as well. This can enable you to pay off other debts or reduce the interest you pay on the loan.
When is an FHA Loan Not Suitable?
When a borrower has less than a 20% down payment, private mortgage insurance will need to be paid each month. While this is the same situation with conventional home loans, the FHA requires an additional upfront premium.
On top of this, when you have more than 20% equity in your home with a conventional loan, PMI will no longer be charged. But with an FHA loan, it will be continued to be paid unless you refinance.
This issue can make FHA loans more expensive when compared to conventional loans and other types of government-insured mortgages.
If you have served the country in the military or are currently serving, you can benefit from a VA loan. The program allows veterans to qualify for a mortgage with no down payment requirement (closing costs still apply and down payment determined based on available entitlement), avoiding the need to wait for years to save enough money.
The eligibility rules mean that more people than you might imagine could qualify for a VA loan. Aside from serving full-time, the national guard and reserves also qualify along with cadets and midshipmen in the naval academy. Surviving spouses of veterans and even descendants can also benefit from this home loan program.
They also have minimum days of service requirement, though this will depend on when you or your spouse served.
While the VA doesn’t require borrowers to pay private mortgage insurance when they have less than 20% equity, they do have a funding fee that borrowers need to pay. There are some exemptions if you suffer from a disability, but otherwise, this fee will be between 1.4% and 3.6% of the loan amount depending on your down payment.
Lower closing costs
VA loans also reduce the amount you will pay in closing costs. There are certain costs that other borrowers will pay that a veteran won’t (the 1% can be charged using the title of underwriting or processing).
More options and no penalties
You can choose from either fixed or adjustable-rate mortgages over periods between 10 and 30 years. Adjustable-rate mortgages will have a period of a lower fixed interest rate that could be as long as 7 years.
If you choose to pay off your mortgage early, you don’t have to worry about prepayment penalties. So whether you are paying a lump sum to reduce your mortgage or increasing your monthly payments, you won’t be penalized for doing so.
With a VA loan, you might be able to buy another home after defaulting on a previous mortgage. While you can expect to face more scrutiny and still meet the normal debt-to-income requirements, it could help you recover from financial difficulty.
You may also be able to qualify for a second VA mortgage if you have a Permanent Change of Station (PCS) or other change in family circumstances.
Qualifying for a VA loan
Even if you meet their veteran requirements, you will still need to meet their debt-to-income ratio rules to be approved for a loan. When mortgage payments are included on top of other debts, this cannot be more than 41% of the borrower’s monthly gross income.
They also have guidelines about how much discretionary income should be left over after paying debts. This gives the borrower enough money to pay for food, clothing, utilities, and other necessities of life, and is part of the reason why these mortgages have the lowest rates of default.
When You Should Not Choose a VA Loan
VA loans are not suitable for persons who have not served or been a spouse of someone who has. If you are not a veteran you cannot benefit from this no down payment requirement government program.
If you do not need to use their no down payment option and have 20% already saved, this type of loan may not be your best choice. With a 20% down payment, you can avoid the funding fee required by the VA by using a different type of mortgage.
The VA loan program allows veterans to refinance at a lower rate through their streamline refinance option. However, if you want to cash out when refinancing, you are limited to 90% of the value of the home. This might mean that you receive less money when the funding fee is included compared to other options.
Also, refinancing your loan into a conventional mortgage can be better when you have a good amount of equity. If you do not use a VA loan you will not have to pay their funding fee.
Even if you don’t think a USDA loan is available to you because you don’t live in a rural community, you might be surprised to find out you qualify. More people can qualify for this government-insured loan program than you might imagine.
Even if you live in a suburban community, you could find that your location makes you eligible for this type of loan.
The USDA also offers home loans to people with lower credit scores. The home has to be your primary residence, cannot be a working farm, and be in good condition to meet the USDA’s minimum property standards.
No down payments
Like VA loans, you can get a mortgage without a down payment requirement through the USDA. While there will be an upfront guarantee fee, you do not have to finance this expense.
To qualify for this type of mortgage, your debt-to-income ratio cannot be higher than 43%. This figure includes mortgage payments, as well as any other debt payments compared to your gross monthly income.
These loans are designed for people with lower or moderate incomes. This is defined as an income that is lower than 115% of the median income in the area. This includes the income of all of the people that are going to live in the home, so it could be a more challenging restriction than it initially appears.
The USDA tends to have fewer restrictions preventing you from buying a home if you have bad credit. If you have had late payments previously, and this happened more than a year ago, they are more likely to be overlooked during underwriting.
Even if you do not have traditional sources of credit, the underwriter could use your payment history to utility or phone companies. They might even use deposits to your saving account to judge the risk you present to the lender. However, this only goes so far, and if you have negative credit, you might find it difficult to be approved.
When you get a loan through the USDA, you will have to pay mortgage insurance. There will also be a guarantee fee that is 1% of the loan amount, though this can be added to the loan and paid back gradually.
On the outstanding balance of your mortgage, you will have to pay 0.35% each year, spread across 12 months. This fee is generally lower than FHA mortgage insurance costs.
When a USDA Loan is Not a Great Choice
USDA loans can also not be used for second homes and investment properties. The home will also need to be appraised to meet the USDA’s minimum property requirements. So if you’re looking to buy a home that needs renovation, other loans will be a better choice.
The USDA has limits on your income if you want to get a loan through their program. This restricts their mortgages to home buyers with moderate incomes.
If you are looking to buy a home in an urban area, this type of loan is unlikely to be available to you. While they do cover many areas that you wouldn’t think are considered rural, urban homes are not going to be eligible.
The USDA program does not offer cash-out refinancing. If you are looking to refinance and take some of your equity as cash, you’ll have to choose another type of loan.
Summing Up FHA, VA and USDA Differences
When you are buying a home, there’s a good chance that you will qualify for one of these government-insured programs. They all have benefits as well as some situations where they won’t be quite as good.
While choosing one of these programs might mean you have to meet different guidelines compared to conventional loans, they can make it easier for you to buy a home with a lower down payment and better terms.
About the author: This article on “FHA, VA, and USDA Loan Differences” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generate new leads from his website.
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