Comparing Loan Products after the Recession: VA, FHA, and Conventional
by Karina Gafford
MilitaryByOwner staff writer
If you have not bought a home in the past couple of years, you may be in for quite a sticker shock. Not only have home prices rebounded across the board, but also interest rates and fees have risen, too. Long gone are the pre-2008 glory days of no money, no job, no problem. A good credit history, financial collateral in the form of savings and retirement accounts, and in most cases, a sizeable down payment represents the new, and understandably more cautious, face of the lending industry.
Financial products that may have suited families just one or two duty stations ago may now come strapped with less attractive features such as additional non-negotiable fees and a flat rate property mortgage insurance for the life of the loan. Yes, the lending market has changed significantly over the past few years, but do not let these changes scare you away from your dream of homeownership. A little education in the updates to the three big mortgage products most regularly used by military families—VA, FHA, and Conventional—can help you determine the best financial path to take for your family. That way, you can quickly return to the fun part of the home-buying process—browsing through the many wonderful options available on MilitarybyOwner to find the kitchen with the largest pantry, the bay window with a built-in window seat for reading, the above garage room that would make the perfect "man cave," or the lush, grassy yard that your dogs and children will play in for hours, providing you peace and quiet in your home! You did want to spend the majority of free time choosing the perfect home, and not the perfect loan product, right?
This article should provide you with a good working understanding of how VA, FHA, and Conventional loans compare with the intent of arming you with sufficient background data to help you speak more knowledgeably with a mortgage lender. As Gregory Meyer, financial educator and blogger at The Credit Union Guy, explained to MBO, "There is nothing more formidable than an informed consumer!" There are many mortgage specialists available through MBO who can help you best determine which of these loan products you qualify for, and which will work best for your family.
For the purpose of this article, we will assume that you are purchasing a primary residence for your family, which means that, in good faith, you intend to occupy the property within 30 or 60 days of closing, depending on the particular lender, for at least a period of one year. Further, we will assume that the loan will be for a typical period of 30-years; a 15-year mortgage will most always have a better interest rate, but it is not as popular an option as the 30-year, which provides for a lower monthly payment by spreading payments out over a longer period.
Selecting a loan product involves far more than simply the advertised interest rate. Meyer explains that when considering the cost involved in a loan product, "The real question is how much [are] the overall cost of the loan fees and interest rate vs. the length of time they might remain in residence there?" For military families who face the prospect of moving every couple of years, the price of a loan for a short-term loan may ultimately cost more than renting at a higher price for the duration of the assignment.
Investing in a home for a longer period, however, reduces the impact of the initial costs involved by spreading them out over time. George Beylouny, branch manager of Silverton Mortgage Specialists of Atlanta, emphasizes the importance of military families considering what the future may hold in terms of an impending next move when selecting a loan product. Beylouny suggests a list of items to consider for families in the market for a loan, which we will address under the VA, FHA, and Conventional Loan below: 1) down-payment, 2) closing costs, 3) mortgage insurance, and 4) up-front mortgage insurance or fund-in fees.
The VA loan is a mortgage financially backed by the US Department of Veteran’s Affairs for the purpose of helping servicemembers and surviving spouses buy a home. In order to qualify for this mortgage, applicants must submit a VA Form 26-1880 to show eligibility for the loan to a lender. Of the three loans products, the VA loan has the lowest credit score requirements, according to Meyer, as the VA itself does not require a credit score, but lenders who work with them do require at least a 620. Further, the VA is the only mortgage that does not require a down-payment or a monthly mortgage insurance fee. Essentially, the only out-of-pocket expense involves paying for an inspection of the property. In terms of closing costs, the VA has the most protections in place, limiting or forbidding many fees, including termite inspections and broker fees or commissions. Under a VA loan, the closing cost fees may add up to no more than 4-percent of the loan; however, this does not include origination charges, which are used to buy down interest rates.
The VA loan does have a limiting factor of far lower loan limits than a conventional loan. Traditionally, the VA loan is capped at $417,000; however, in some parts of the country, this sum is not sufficient to purchase a family home, and so the cap rates for the loan are higher. These caps are set by individual counties, and not by the VA. For example, in Anchorage, AK, the loan limit is $625,500 for 2013; whereas, in Stafford, VA, the loan limit is $843,750.
While no mortgage insurance or down-payment exists, the VA does require a funding fee of between 1.4-percent and 2.15-percent for those using the VA loan for the first time. This funding fee occurs in addition to closing costs, but borrowers do not have to pay this fee upfront; instead they can roll the funding fee into the loan itself. Some borrowers, such as spouses who lost their servicemember in action or veterans who receive a service-connected disability, do not have to pay the funding fee while National Guard and Reservists pay a slightly higher fee of up to 2.4-percent. Despite the funding fee, though, the lower interest rates offered by the VA combined with limits on closing cost fees generally provide the best deal for those seeking a no down-payment loan.
The FHA loan is the Federal Housing Authority’s low down-payment loan, requiring only a 3.5-percent down-payment, and unlike the VA loan, the FHA loan is available to nearly everyone. As with VA loans, the FHA loan allows for what Meyer explains as a more "relaxed" credit environment. With over 30-years of banking and lending experience, Meyer explains that the FHA can often operate with buyers with a FICO credit score of 620.
Similar to the VA loan, the FHA loan also has lending limits determined by county. Looking again at Anchorage, the loan limit for a single family house is $355,350. However, a family could also choose to purchase a duplex for $454,900, or even a four-plex property for $683,350. There are also limits on closing costs, just as with a VA loan; however, these limits are not as restrictive as those of the VA and are based on local FHA offices rather than one set standard.
Just like the VA loan, too, the FHA loan features a funding fee, but it is lower than that of the VA at 1.75-percent. However, unlike the VA loan, the FHA also has a monthly Premium Mortgage Insurance (PMI) fee of 1.35-percent that amounts to just over $100 each month for either 10-years or the life of the loan. Previously, FHA limited PMI to a period of approximately 5-years and the owner must have over 22-percent equity in the home. These costs quickly add up, as Phil Georgiades of VA Home Loan Centers explains, "…on a $100,000 loan it will add $112.50 to the monthly payment. For the typical homebuyer it will add $215.00 to the monthly payment."
Mark Feder, a mortgage advisor in Solana, CA, explained to MBO that, for the longest time FHA was simply catching the least loan worthy borrower and they were "the most cumbersome" loan product for lenders to work around. When the market crashed and housing prices dropped, however, he explains that FHA essentially became a "first time home buyer program," offering lower credit, lower interest, and lower down-payment lending when others would not. Given that FHA works with riskier loans, they suffered huge losses in the market crash. Now, in an effort to recover from their financial losses, they are raising rates substantially, such as the PMI mentioned above. As Feder explains, the additional costs involved with an FHA loan will cause good, qualified borrowers to look for alternative options while "FHA are only going to be left with the most credit starved." For those who suffered credit losses as a result of job loss during the recession, an FHA loan does have an upside, as it may prove the quickest way to get back into the housing market while home prices are still low. Feder suggests that those who wait several years for their credit rate to recover in order to get a conventional loan with a lower interest rate may find that the gain in house prices quickly offsets any loss they may have taken by paying mortgage insurance for an FHA loan now.
Whereas the VA and FHA loans share many similarities, the Conventional loan is a completely different breed of mortgage. Of each of the loan products discussed, conventional financing requires both the highest credit score and highest down-payment, yet the 30-year Conventional loan still comes with the highest interest rate, too. Given that data, the Conventional does not seem too attractive, but there are upsides. No government-backed body limits closing cost fees, but neither mortgage insurance nor funding fees exist for loans with down-payments above 20-percent either, saving those who qualify for a Conventional loan a substantial amount of money over the life of the loan, explains Georgiades.
The Conventional is the most difficult of the three loans to qualify for though. While those accepting an FHA loan can receive their down-payment as a gift, for instance, from a parent, those applying for a Conventional loan may not receive any portion of the down-payment as a gift. As Feder explains, "You must show a history of responsibility and savings" to qualify for the Conventional.
In the event of choosing to go with a Conventional loan, the borrower must do due diligence through calculations to ensure that he is getting the best value for his dollar by parting with more dollars up-front. In most cases, a down-payment requires a full 20-percent of the mortgage, but a new proposal in Congress suggests that 30-percent down-payments may soon become a reality.
Therefore, the Conventional loan best suits those with money on hand to support the hefty down-payment, but who wish to find savings through a lower monthly payment and no funding fees or mortgage insurance.
Always Get a Good Faith Estimate
After discussing the loan product that best fits your needs with your lender, always make sure to request a written copy of a Good Faith Estimate (GFE) for the particular loan for which you would like to apply. A GFE is a three page document that outlines all of your estimated costs for a loan, and lenders should provide one within three days of an application for a loan. Receiving a GFE does not mean that you need to accept the loan, but it will provide you with written documentation for both comparing with figures from other lenders and comparing with the final HUD-1, the Settlement Statement that you should receive for review at least one day prior to closing.
Hopefully you now have a good working understanding of how VA, FHA, and Conventional loans compare, so that you can more knowledgeably discuss these options with your lender. You may also want to try out some calculations online to have a better idea of how interest rates and fees may affect your payment. When shopping for a lender, make sure to check out MBO’s Business Directoryto find someone to work with in your local area. Once you have bought your primary home, make sure to check back for following articles in which we will discuss purchasing for long-term investment, the possibility of using a second VA loan, and the mortgage discrepancies between buying a primary home and a secondary or rental investment home.