There’s no automatic “best” when it comes to home loans. When you’re shopping for a mortgage, you’ll find that there are pros and cons to each mortgage type, as well as financial trade-offs that depend on your specific situation.
Credit, income and assets certainly come into play when assessing mortgages, but the best product for you can depend on a number of variables. A family looking to purchase a vacation house, for example, will have different home loan needs than someone shopping for a primary residence.
Let’s take a closer look at the four major loan types (conventional, FHA, USDA and VA) in light of some realistic numbers. According to the most recent VA data, the average VA mortgage in 2016 was $253,272. For the purpose of a simple comparison, we will compare each loan type using a $250,000 mortgage.
Using a more specific example can often highlight some of the biggest advantages and disadvantages of your potential mortgage options.
We’ll start with some basic assumptions: You’re a first-time homebuyer considering a 30-year fixed-rate $250,000 mortgage with an interest rate of 4.5 percent. We’ll also use a consistent estimate for the monthly costs of property taxes and homeowners insurance (a combined $260), but keep in mind these latter two figures can vary widely depending on where you're buying and other factors.
Last, we’ll assume that you’re making the minimum required down payment for each loan type and financing any upfront mortgage insurance or funding fee into the loan.
Given all those things, here’s a look at the monthly payment breakdown:
|Loan type||Minimum Down Payment||Funding Fee||Principal & Interest||Taxes & Insurance||Mortgage Insurance||Monthly Payment|
The chart makes clear how paying mortgage insurance each month can take a toll on your bottom line. FHA loans in particular have become increasingly expensive for many homebuyers. Conventional buyers who can't put down 20 percent typically pay for private mortgage insurance (PMI) each month. For this example, we used a PMI rate of 0.6 percent.
For conventional borrowers, PMI drops off after you've established 20 percent equity in your home. FHA and USDA loans have lifetime mortgage insurance. VA loans don't carry monthly mortgage insurance for homeowners, which can mean big savings when it comes to your monthly payment.
Let’s take a closer look at the ups and downs of each of the four main loan types.
FHA Loans: With a low 3.5 percent down payment option and lax credit requirements, FHA loans open the door to homeownership for those who aren’t VA eligible and can’t qualify for a conventional loan. The looser guidelines come at a cost, though. FHA mortgage insurance rates are higher, and they don’t end once you’ve earned equity in your home. Upping the down payment to 5 percent will reduce the mortgage insurance rate slightly, but conventional loans will cost less in the long run for those who can sufficiently improve their credit scores.
USDA Loans: Aside from the VA loan, the USDA program is the only other option for buyers who aren’t willing or able to make a down payment. USDA loans also have lower credit requirements and mortgage insurance rates than the other loan types. The trade-off comes in the form of restrictions. USDA loans are eligible only to buyers looking at homes in rural areas as defined by the loan program. You’ll also need to prove that your income doesn't exceed 115 percent of the area's adjusted median income.
Conventional Loans: Unlike the VA loan, conventional products often require a down payment of at least 5 percent, though you won’t be free of PMI unless you put down 20 percent. Having a lot of equity in your home from the outset is great—if you can afford it. Those who don’t have a big down payment will pay typically PMI every month until their loan-to-value ratio hits 80 percent. For buyers with excellent credit and plenty of assets, conventional loans offer flexibility (you can use them to buy fixer uppers or vacation homes) and competitive rates.
VA Loans: The most obvious benefit of the VA loan program is a big one—eligible veterans and active duty military families have the option to buy with no money down. On the flip side, no down payment means you start your life as a homeowner with no equity in your property, making you more susceptible to fluctuations in your local real estate market. The VA Funding Fee is typically rolled into the loan. Still, with no PMI, the VA loan usually costs less on a month-to-month basis. Pair that with VA mortgage rates being some of the lowest on the market and the VA loan starts to look like a great deal.
The mortgage you ultimately choose could have implications for your interest rate, monthly payments, and even your purchasing power. It’s crucial to do your research to find a product that suits your goals and your ability to qualify. You can get a look at possible mortgage payments and your purchasing power using our VA loan calculator.
It's a good idea to run the numbers yourself or have a loan officer you trust do the same. Again, every homebuyer's situation is different. It's important to find the right loan given your goals and your specific financial circumstances.
No matter what, don't put any stock in the misconception that using your hard-earned VA home loan benefits automatically means you'll spend more. Move past the myths and take a closer look at what might make the most sense for you.
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