VA loan series: VA vs FHA vs USDA
Ridiculously good benefits for eligible VA buyers
VA-qualified borrowers can obtain mortgage financing with very advantageous terms. How advantageous? How about no money down? And no monthly mortgage insurance costs?
Purchasing a home with 100% financing means that if the property costs $300,000 you can get a $300,000 mortgage. You don’t have to save for a down payment. So how do the advantages (and eligibility requirements) of a VA loan stack up against USDA and FHA loans?Ready to buy a home? Discover rates with today's top lenders. (Dec 7th, 2019)
VA mortgages versus USDA rural development loans program
Both VA and USDA borrowers can purchase with nothing down. However, the VA and USDA programs are not apples and apples.
The USDA program is for rural areas. However, USDA financing can be used in an estimated 97 percent of the country, at least as far as geographic land mass.
Population-wise, you may have a tough time qualifying for USDA if you want to buy within commuting distance of a major city.
A second restriction of USDA concerns income.
Under the USDA program, borrowers with incomes that exceed 115% of the median income for the county or area where the property is located.
Following are maximum household income limits for certain areas:
- Boston, Massachusettes $116,600
- Seattle, Washington: $125,950/yr
- Amarillo County, Texas: $82,700
- Chicago, Illinois: $97,300
If you have a high-paying job or a two-income family, you may not qualify for USDA.
The VA loan program has no income limitation. You can make $1 million per year and still qualify for VA.
USDA loans have an up-front guarantee fee equal to 1% of the loan amount and 0.35% annually. The up-front fee is cheaper in most cases that up-front fees for the VA and FHA programs. The annual fee is less than the FHA charge but more than borrowers pay with the VA program, a program which does not have an annual fee.
Lastly, and strangely, USDA financing depends on the federal budget. The program must be re-approved by Congress regularly, or lenders can’t do the program. In some cases – USDA loans are literally unavailable because of budgetary issues.
VA vs. FHA financing
The biggest advante of VA over FHA is that FHA requires 3.5% down.
In addition, FHA borrowers pay an upfront mortgage insurance premium equal to 1.75% of the mortgage amount. That’s more than $5,000 in the case of a $300,000 home.
The upfront MIP does not have to be paid in cash, FHA borrowers can add it to the mortgage amount. The amount owed goes up but the additional expense is paid out over a 30-year schedule. At 4.25%, adding $5,000 to a 30-year mortgage will increase the monthly cost by $25.
The is also an annual FHA mortgage insurance premium (the annual MIP). In the case of a $300,000 property, the premium will be $209 a month.
In the case of the $300,000 property, a VA borrower will save the up-front MIP ($5,000), and the annual MIP ($209). If the property is held for nine years the total cost for the annual MIP is $22,572 ($209 x 108 months). So far, our VA borrower is ahead by about $28,000
But, while VA borrowers do not need cash for a down payment or mortgage insurance, they do have a cost which is unique to the VA program. They must pay an upfront funding fee.
The funding fee & VA loan service requirements
In reality, there’s no difference between an FHA up-front insurance premium and a VA funding fee. They’re both costs. However, there is an important difference between the two charges. With the FHA one size fits all. Purchase a $300,000 home with 3.5% down and the up-front MIP is 1.75%. With the VA program the funding fee can vary. This is where VA loan service requirements really come into play.
The FHA program is an insurance plan. You pay premiums and if something goes wrong the FHA will pay off the lender. The VA program is essentially recognition for military service. It looks at the borrower and their service to the country. It’s a way of saying thank you, in part a moral obligation to those who have served. It’s not just a business deal.
The result is that some borrowers will not pay a funding fee. According to the VA, you do not have to pay the fee if you are a:
- A veteran receiving VA compensation for a service-connected disability, OR
- A veteran who would be entitled to receive compensation for a service-connected disability if you did not receive retirement or active duty pay, OR
- A surviving spouse of a Veteran who died in service or from a service-connected disability
Regular Military of Reserve/National Guard
The VA program makes a distinction between service in the Regular Military and service in the Reserves and National Guard. How much you put down is important and the VA also considers first-time usage.
As home prices have appreciated in many markets VA-qualified borrowers – like other borrowers – have elected to get cash-out refinances. For example: the value of a $300,000 home goes up to $400,000 over a period of years. The VA borrower gets a replacement loan, one that pays off the balance of the original mortgage and pulls $50,000 in cash from the property.
Unfortunately, some cash-out refinancing transactions resulted in situations where VA borrowers paid excessive fees and were sold the idea of multiple refinancings which resulted in significantly higher loan origination costs. The VA – which takes the protection of VA borrowers very seriously – issued new rules to prevent cash-out abuses.
Seasoning. A cash-out refinance will not qualify for a VA loan guarantee unless it is originated at least 210 days after the first monthly payment has been made on the current financing and six monthly payments have been made on the loan. This rule prevents serial refinancing.
Required savings for VA cash-out loans
Recoupment. This is a fancy term which means loan savings must be enough to get back the expenses paid for a cash-out refinance within 36 months. Costs can include such expenses as fees, closing costs, expenses, and incurred costs. This rule is designed to prevent excess charges and fees.
Net benefit test. The VA will not approve a cash-out refinance unless the borrower can benefit from the new financing. At least one of the eight allowable benefits must be shown. The eight benefits include:
- The new loan eliminates monthly mortgage insurance, whether public or private, or monthly guaranty insurance.
- The term of the new loan is shorter than the term of the loan being refinanced.
- The interest rate on the new loan is lower than the interest rate on the loan being refinanced.
- The payment on the new loan is lower than the payment on the loan being refinanced.
- The new loan results in an increase in the borrower’s monthly residual income.
- The new loan refinances an interim loan to construct, alter, or repair the home.
- The new loan amount is equal to or less than 90% of the reasonable value of the home, or;
- The new loan refinances an adjustable-rate loan to a fixed-rate loan.
Cash-out refinancing charges. Reduced funding fees can apply to purchase loans with a down payment of at least 5%.
The VA also has reduced fees for certain types of refinancing, including an IRRRL. An “IRRRL” or Interest Rate Reduction Refinancing Loan, is essentially a rate-and-term refinance, a new loan for the same amount but with a lower rate.
Check your eligibility for VA
If you’ve served in the U.S. military, it’s worth checking your eligibility for a VA loan.
For details and specifics, speak with VA lenders. Shop around for the best rates, whether getting a VA loan to purchase or refinance a property.Verify your new rate (Dec 7th, 2019)