With no down payment and no mortgage insurance, VA loans are a better financial bet than FHA loans.
The past few years FHA loans have been enormously popular. This is largely a byproduct of the fact that FHA financing is a known quantity; these loans have been used by more than 37 million borrowers since the 1930s.
No less important, FHA financing is safe. Like VA loans, an FHA mortgage doesn’t have any “gotcha” clauses that create unfair costs or surprise foreclosures.
The popularity and safety of FHA financing raises a question: Instead of getting a VA mortgage would it make more sense to get an FHA loan now and save your VA entitlement for later?
There are certainly arguments on both sides of the question, but let’s look at some numbers.
FHA v. VA Loans
First, if you buy property with VA financing there’s no down payment requirement. The FHA program requires borrowers to put down at least 3.5 percent. For a $200,000 mortgage the difference is plain: Zero down at closing versus $7,000. In both cases closing costs are additional.
Second, both the VA and the FHA financing programs are not really loans; they are instead insurance. The actual money for the loans comes from the private sector. The VA and FHA simply provide insurance for loans that meet their standards.
Where there’s insurance there’s a premium. In the case of the VA, the up-front VA Funding Fee depends on whether you’re Active Duty/Retired or in the Reserves/Guard. Also, the fee varies according to how much you put down and whether you’ve used your entitlement in the past.
For purposes of comparison, let’s say you put down zero dollars, have not used your entitlement before and are on active duty. Your funding fee would be equal to 2.15 percent of the loan amount.
With the FHA program, the up-front mortgage insurance premium — the MIP — would be equal in most cases to 1 percent of the loan amount. For a $200,000 loan, the VA Funding Fee would be $4,300 while FHA borrowers would pay $2,000.
Third, the funding fee with the VA is a one-time deal. You can pay it up front, but most borrowers ask the seller to cover the cost or choose to roll the fee into the mortgage to lower their cost at closing.
With the FHA, the up-front MIP is lower than the typical VA insurance cost, but the FHA requires not only an up-front MIP but also an annual MIP. The FHA annual MIP would be 1.15 percent of the outstanding loan amount.
Because the loan amount goes down as the mortgage is paid off, the exact cost of the FHA’s annual MIP declines a little with each monthly payment. In rough terms, for a $200,000 the annual MIP would equal $2,300 per year or $191.67 in the first month of the loan.
VA Loans Come Out on Top
So, if you look at the numbers you can see that the VA requires a lower down payment — nothing versus 3.5 percent. The up-front cost of insurance is higher for the VA program — but unlike the FHA the VA has no annual premium, a substantial savings.
As an example, in the first five years of the loan term, our FHA borrower with a $200,000 mortgage and a 4 percent interest rate will likely pay roughly $11,000 in annual insurance fees — while our VA borrower will pay zero.
Both the VA and the FHA programs represent excellent forms of financing, but VA mortgages are simply a better financial deal for most qualified borrowers.
