At first glance, FHA loans and VA loans appear very similar. Both are mortgage loans backed by the federal government. Both guarantee loans made to qualified buyers by banks and other mortgage lenders – neither the FHA nor the VA lend money directly.
The main difference is eligibility.
Everyone is eligible for an FHA loan, while VA loan eligibility is limited to veterans, active service members, members of the National Guard and Reserves, plus some surviving military spouses.
What Is an FHA Loan?
The Federal Housing Administration, part of the Department of Housing and Urban Development, or HUD, was created in 1934, during the depths of the Great Depression. The FHA was intended to make home ownership possible for low- and moderate-income first-time homebuyers.
FHA loans are intended to help homebuyers with fair credit scores, moderate income, or who are struggling to save enough to make a down payment on a home.
Advantages of an FHA Loan
An FHA loan can be the best route for a first-time homebuyer to realize the American dream of home ownership – despite the American reality of average credit rating and low or middle income. The FHA can give homebuyers specific advantages:
- Competitive interest rates compared to conventional loan rates.
- Lower down payments than conventional mortgages. With an FHA loan, you may be able to buy a house with a 3.5% down payment (assuming your credit score is at least 580).
- Lower credit score requirements are possible because your lender knows the FHA will guarantee your loan even if you default. That reduced risk allows lenders to extend credit to borrowers that might fall short of normal requirements.
- Fixed interest rates, available in FHA loans, give you certainty about your monthly mortgage payments.
- Your debt-to-income (DTI) ratio is a key metric for lenders deciding whether to approve a mortgage loans. With an FHA loan, your DTI can be as high as 43%.
Disadvantages of an FHA Loan
There are disadvantages to an FHA loan, especially when compared to a similar VA loan. They include:
- Mortgage insurance is required, and that will raise the cost of your home. An upfront mortgage insurance premium of 1.75% of the loan amount is paid at closing. Monthly mortgage insurance premiums are added to your mortgage payment over the life of the loan.
- Because of FHA limits, you have less buying power with an FHA loan. The maximum loan amount in 2023 ranged between $472, 030 and $1,089,300, depending on the county in which the house was located. That limit may be irrelevant to a first-time homebuyer with a moderate income.
- FHA loans are available only for your primary residence – not for vacation homes, rental properties or investment properties. Again, this is a disadvantage that may not apply to a first-time homebuyer.
What is a VA Loan?
As World War II ended and thousands of veterans returned to their hometowns, the government took steps to help those who had sacrificed so much. One way was to help veterans and active- duty service members realize the American dream of home ownership. The Veterans Administration created a program to guarantee the mortgages of qualified applicants so that banks and other lenders would approve loans without demanding high incomes or large down payments.
Nearly 80 years after the first VA mortgages were approved, there are different types of VA loans available. These loans have very definite advantages for veterans, active-duty service members, National Guard members, Reservists, and surviving spouses of deceased military members.
Advantages of a VA Loan
Potential homeowners have a variety of options when it comes to buying that first home. Some people may have saved enough money for a down payment or have family or friends who can make a down payment for them. Others may turn to the Federal Housing Administration (FHA). Veterans and other military personnel have the same access to those options, but they have the additional option of a VA loan.
There are definite benefits to VA loans:
- No down payment is necessary. This is the headline grabber. Civilians may spend years saving enough money for a down payment, years you spent serving your country. Here, your country evens things up by guaranteeing the loan and eliminating the need for a down payment.
- No private mortgage insurance (PMI) is required. PMI is required for conventional loans if the down payment is less than 20%. It is a way of protecting the lender from early default on the loan. Here, the VA provides that protection.
- That guarantee counts as one of the benefits because it makes most of the others possible. Lenders view a loan application with risk and reward in mind. If a borrower is considered a higher risk, the lender will use higher interest rates and other means to reduce that risk. A VA loan removes much of the risk for the lender, guaranteeing payment in the event the borrower defaults.
- That VA guarantee also means more favorable interest rates than with a conventional loan. Lenders compete with each other, so shopping around for a lender is a wise move. Even a small difference in interest rates can mean thousands of dollars in savings over the life of the loan.
- More flexible credit requirements are possible with a VA-backed loan. That doesn’t mean no rules, but it does mean more wiggle room than with a conventional loan. The VA has no minimum credit score for loans, although most lenders require a score of at least 680.
- A lenient debt-to-income ratio – your monthly debt obligations vs. your monthly income — is another advantage. The VA suggests a 41% DTI, while some lenders may allow a DTI of up to 55% if your credit score is solid enough.
- There is no “prepayment penalty” if you pay off a VA loan early. You may also sell your property at any time or refinance your VA loan.
- Buying, owning and selling a home are all complicated procedures, and there are multiple VA loans available to help deal with all eventualities. They can be fixed- or adjustable-rate loans (ARMs). There are purchase loans; cash-out refinancing, which provides cash from your home equity; Interest Rate Reduction Refinance Loans (IRRRL), which can reduce your interest rate or convert an ARM to a fixed rate, and Native American Direct Loans.
- VA loans are assumable, meaning you can transfer your mortgage to a new buyer who is also VA-eligible. This can mean a lot, especially if interest rates have risen since you took out the original loan.
Disadvantages of a VA Loan
Don’t jump to the conclusion that VA loans are without disadvantages. They have a few, and it’s best to factor them in before signing anything.
- The VA Funding Fee offsets some of the benefit of no down payment. The funding fee is just that: it is how the VA pays for its loan program. The funding fee is up to 2.3% of the total loan amount. Lenders may also add a 1% origination fee which, like the funding fee, is due at closing. Those fees may be rolled into the mortgage so you don’t have to pay them up front.
- Less home equity is another price paid for not making a down payment. Instead of starting with 10% or 15% equity, the new homeowner must begin building equity from scratch.
- A seller may be reluctant to do business with a buyer using a VA loan. The home appraisal may have stricter requirements. There are also misconceptions about VA loans, such as lengthy closing processes, the seller paying closing costs, or that the lack of a down payment means the buyer isn’t fully committed. Engaging a buyer’s agent is one way to address these concerns.
- VA loans are available only for primary residences, so they cannot be used for second homes, vacation homes or investment properties. Multifamily homes of up to four units are eligible provided the borrower lives in one of the units.
- There is a higher funding fee for second loans and beyond. If you take out a loan with a 2.3% funding fee, a refinance loan would be 3.6% of the total amount.
- Not all mortgage lenders offer VA loans. It is important to shop around for the best interest rate, which should also help rule out unavailable lenders. The VA publishes quarterly reports that show who is lending money, giving a shortcut for eligible borrowers to find available lenders.
Differences Between FHA and VA Loans
The federal government sought to encourage home ownership with programs designed to help buyers with low to middle incomes or those unable to make a down payment. The Federal Housing Administration offers protection to lenders to encourage home buying. The Veterans Administration provides similar to protection so that lenders will work with veterans, active military, National Guard and Reservists.
FHA loans are intended to help those who may not be able to afford to buy a home. The FHA guarantees loans made by banks and other lenders to borrowers with lower incomes or poor credit scores.
VA loans are similar except they are available only to active military servicemembers, veterans, National Guard and Reserve members and, in some cases, surviving spouses of servicemembers.
Credit Score Requirements
Because the loans are backed by the government, lenders lower their conventional qualification requirements.
For an FHA loan, you’ll typically need a credit score of at least 580. If a borrower is able to put down a down payment of 10% or more, the lender may accept a lower credit score.
The VA does not enforce a minimum credit score. Many lenders, however, do set limits on credit scores.
Before applying for a VA or FHA loan, it may be a good idea to improve your credit score.
With an FHA loan, you will be required to pay mortgage insurance premiums (MIP). At closing, you will owe 1.75% of the loan as an upfront MIP. Then, you pay insurance monthly as part of your loan payment.
The VA does not require mortgage insurance as part of its loan program.
There are limits to how much you can borrow under both federal loan programs.
FHA limits are consistently set at about $472,030. The VA limit is higher — $726,200 – but that can vary depending on the county you are buying in. Also, for veterans with full entitlement, as of 2020 loan limits no longer apply.
Putting money down is one of the higher hurdles for first-time home buyers to clear. Federal loan programs help to lower that hurdle.
A VA loan requires no down payment, which is one of the VA program’s most attractive qualities.
An FHA loan requires the buyer to put down 3.5% of the total cost of the home. That is lower than a conventional loan, but significantly different from a VA loan. On a $200,000 house, a VA loan requires zero dollars down while an FHA loan would require at least $7,000.
Closing costs may feel like the mousetrap snapping on your fingers just as you near the end of the home-buying process. =Three business days before closing, you should receive a Closing Disclosure, which lays out all the costs. They can include fees for attorneys, applications, credit reporting and appraisals.
VA loans add a funding fee at closing. For a first-time buyer, the funding fee is 2.15% of the loan amount. That number can be lowered to 1.25% by making a 10% down payment.
FHA loans include standard closing costs as well as mortgage insurance premiums.
FHA or VA Loan: Which is Right For You?
That choice is pretty much made for you. If you are eligible for a VA loan, that is usually the better option. One exception: getting a good FHA deal while maintaining your VA eligibility for a future occasion.
Bottom line: With a VA loan, you can purchase a home with no money down, no mortgage insurance premiums and lower interest rates. By rolling the VA funding fee into the loan, you can trade the upfront payment for a slightly higher monthly obligation.
Regardless of your choice, it is important to shop around for the best possible interest rate and other costs. Even a fraction of a percentage point can save you thousands of dollars over the life of a loan.
About The Author
Phil Sheridan writes about military benefits for Military Money. Phil spent over 30 years learning about labor negotiations, salary caps, stadium negotiations and a lot of other finance-related matters as a reporter and columnist for the Philadelphia Inquirer and ESPN.
- Birk, Chris (2022, November 15) How VA Loans Work: What Most Borrowers Don’t Know About VA Loans. Retrieved from https://www.veteransunited.com/valoans/10-things-many-borrowers-dont-know-about-va-loans/
- Crace, Miranda (2023, March 19) Closing Costs: What Are They, And How Much Will You Pay? Retrieved from https://www.rocketmortgage.com/learn/closing-costs
- Grace, Molly (2023, March 19) FHA Vs. VA Loans: What’s the Difference, and Which One Is Best For You? Retrieved from https://www.rocketmortgage.com/learn/fha-vs-va-loan
- Kassraie, Aaron (2022, April 25) 10 Things You Didn’t Know About the VA Home Loan Program. Retrieved from https://www.aarp.org/home-family/voices/veterans/info-2022/va-home-loan-program/