‍What Are FHA and VA Loans?‍

FHA and VA loans provide access to homeownership for those who might otherwise struggle to achieve this dream. Although insured by different entities, these loans offer backing for lenders such as banks and credit unions. This encourages them to provide favorable terms to applicants they would otherwise deny for credit or finance reasons.

How Do FHA Loans Work?

Insured by the Federal Housing Administration, FHA loans are mortgages designed to help aspiring homeowners with limited savings or problematic credit histories. Under this program, the FHA backs loans with approved lenders such as credit unions or banks. The main appeal of this program lies in the opportunity it provides to acquire funding with only a 3.5 percent down payment.

Basic FHA Loan Requirements

FHA loans are open to a variety of applicants who might not otherwise qualify for standard financing when purchasing homes. Still, the program holds a few basic requirements that applicants must fulfill:

• The absolute minimum credit score for this program is 500. To be eligible for the 3.5 percent down payment, applicants must have a credit score of at least 580.
• Debt-to-income ratio requirements can vary from one year to the next. In general, however, applicants are more likely to secure financing with a ratio of 45 percent.
• Applicants must provide evidence of stable income. This may take the form of W2 statements or pay stubs. Business owners or independent contractors may need to provide invoices, contracts, or other indications of income.
• Property approval is required. Not all homes qualify for FHA loans. The program puts limitations on the loan amount while also maintaining strict standards to prevent participants from buying homes in a clear state of disrepair.

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FHA loan applicants must meet minimum down payment and credit score thresholds.

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FHA Loan Benefits

Increased accessibility is the greatest benefit provided by the FHA loan program. Those who are unable to qualify for mortgages under typical circumstances may be able to obtain funding through this program. This is possible even with minimal savings or poor credit. Equipped with an FHA loan, buyers don’t have to feel trapped by the rental market.‍

Low Down Payments

Conventional wisdom points to the need for a 20 percent down payment prior to purchasing property. With FHA loans, however, it's possible for applicants with a credit score of 580 or greater to score a mortgage with a down payment of just 3.5 percent. Those who fail to meet this credit threshold may still be able to qualify, assuming they're able to put up a 10 percent down payment.

Minimal Credit Requirements

While FHA applicants should have some form of credit history, it's possible to secure funding with less-than-stellar credit. The average credit score in the United States is 680, so most aspiring homeowners will be able to meet the minimum score of 500.

Variety

FHA makes it possible to pursue a variety of mortgage loan products. Fixed-interest rate loans are most popular, with the majority of buyers opting for the traditional 30-year, fixed-interest approach. Others prefer to pay off these loans in as few as 10 or 15 years.

Although riskier and generally not as advisable for low-income homebuyers, adjustable-rate arrangements are also available.

Key benefits of FHA loans include minimal credit score requirements, low down payments, and loan variety.

FHA Loan Downsides

FHA loans, while helpful for many, are far from perfect. They come with strings attached and can lead to higher payments throughout the entirety of the mortgage period.

Stringent Eligibility Requirements

While FHA loans can be easier for some aspiring homeowners to obtain, they're by no means simple to secure. Because applicants aren’t required to make large down payments or have high credit scores, they must be able to provide proof of steady income and low debt-to-income ratios.

FHA standards may be more lenient than those associated with conventional loans, but they still keep many people from becoming homeowners.

Higher Monthly Costs

While FHA loans are typically marketed to low-income buyers, they can sometimes prove problematic for their long-term finances. In exchange for a reduced down payment, buyers must pay upfront mortgage insurance and continue to do so for the duration of the loan.

While the fees associated with FHA loans are often compared to private mortgage insurance (PMI), they actually prove to be more expensive over time. PMI payments end as soon as buyers reach 20 percent equity, but FHA premiums may continue for years or even decades.

Borrowing Limitations

The FHA loan program prevents homebuyers from purchasing property that exceeds predesignated limitations. Allowed loan levels can vary dramatically based on the geographic region in which the desired home is located.

In some cases, buyers may be unable to borrow more than $330,000. While these limits prevent homeowners from taking on more debt than they can handle, they can also make it difficult to secure property when housing prices are on the rise.

Strict Property Standards

In an effort to protect low-income homebuyers, FHA loans maintain strict standards for the quality of the properties they cover. While some buyers regard this as a clear advantage, it comes with a noteworthy downside: fixer-upper opportunities may be out of reach. Additionally, perceptions of strict appraisals sometimes make sellers reluctant to work with FHA buyers.

FHA loans can be expensive over time and may include limits based on borrowing amounts or home quality.

How Do VA Loans Work?

Guaranteed by the Department of Veterans Affairs, VA loans resemble their FHA counterparts in several respects. The loans are provided by private lenders and backed by the VA.

Basic VA Loan Requirements

VA loans are not as accessible to the public as the FHA program. To qualify for these loans, active service members or Veterans must provide a Certificate of Eligibility (COE) highlighting their service history and current status.

Service requirements for obtaining a COE vary somewhat based on the dates and amount of time dedicated to active duty. Generally, those involved in conflicts such as World War II or the Vietnam War need only have served for 90 days. Likewise, applicants who are currently on active duty can qualify after 90 continuous days of service.

A military background during non-war periods may prompt the need for 181 continuous days or even 24 continuous months of service to qualify.

National Guard and Reserve members are eligible for VA loans if they've served six creditable years and either been honorably discharged or placed on the retired list. Surviving spouses of Veterans may also qualify.

In rare cases, it's possible to qualify for a COE despite not meeting active service requirements. Typically, this occurs in response to discharges related to hardship or service-connected disability.

Beyond meeting basic requirements for time spent serving the military, VA loan applicants must clear eligibility standards established by lenders. These can sometimes prove surprisingly strict.

VA loans are exclusively available to veterans and service members.

VA Loan Benefits

VA loans can produce huge savings for aspiring homeowners, all while allowing them to promptly secure financing. It's easy to see why most eligible Veterans and service members prefer this option. Key benefits worth considering include:

No Down Payment

In many cases, down payments represent the greatest barrier to achieving the dream of homeownership. VA loans remove this hurdle by allowing applicants to secure mortgages without putting any money down.

No Private Mortgage Insurance

For many prospective homeowners, the possibility of paying private mortgage insurance provides a powerful incentive to save enough to put 20 percent down before buying a home.

PMI can add another 1 percent to a home's purchase price, potentially resulting in hundreds or even thousands in annual expenses on top of already considerable mortgage and interest payments. This fear is unfounded for VA loans, which, despite the lack of a down payment, are exempt from PMI requirements.

No Minimum Credit Score

The Department of Veterans Affairs does not mention a minimum credit score in its VA loan eligibility requirements. As such, it is theoretically possible for buyers with poor credit to obtain favorable loan terms, even if they lack the funds for a down payment. That being said, credit still matters, as the private lenders responsible for issuing these loans often impose minimum credit scores in the 600 range.

The VA loan removes the need for a down payment while also making mortgages accessible to Veterans and military personnel with poor credit.

VA Loan Downsides

No down payment, no PMI, no minimum credit score...what's not to love? Turns out, the VA loan holds a few notable downsides worth considering:

Strict Eligibility Standards

Qualifying for VA mortgages can be difficult and time-consuming. Simply obtaining a Certificate of Eligibility may prove challenging for some applicants. Those who do not qualify on the basis of active duty status or honorable discharge may need to produce evidence to support their eligibility.

Gaining a COE only represents the beginning of the process. Prospective homeowners must also work with lenders, following many of the steps associated with conventional homebuying.

Seller Resistance

Unfortunately, not all sellers are enthusiastic about working with aspiring homeowners backed by VA loans. While sellers are barred from ruling out buyers on the basis of race, ethnicity, or disability, it's perfectly legal for them to refuse to sell based on the method of financing. In fact, most don't consider it discriminatory to choose buyers with conventional loans over those involved in the VA program.

Many sellers believe they are justified in avoiding buyers backed by VA financing. They cite administrative issues, such as longer appraisal periods or picky home inspectors. Furthermore, sellers worry that it will ultimately cost them more to accept VA loans.

Funding Fees

Every VA loan recipient must pay a one-time funding fee. This aims to reduce the burden of the VA loan program for U.S. taxpayers. Otherwise, it could be difficult to keep up with the cost of covering down payments for military personnel.

The VA loan's funding fee can be financed over time as part of the loan or paid during closing. The total fee depends on the type of loan and its amount. The presence of a down payment can also impact the fee. In some cases, VA funding fees can exceed those associated with FHA loans.

In select circumstances, the VA funding fee can be waived. This typically occurs for anyone with a service-connected disability. Waived fees are also possible for surviving spouses of Veterans who died while serving.

Problems with VA loans include funding fees and seller resistance.

Takeaways: FHA vs VA Loan

FHA and VA loans provide valuable opportunities for realizing the dream of homeownership. These programs limit the burden of obtaining a down payment while also providing a realistic option for homebuyers with poor credit. However, while they hold several similarities, these programs should not be confused for the following reasons:

• Eligibility for FHA loans depends on credit score and income, while VA loans are only available to Veterans, active duty service members, and select additional homebuyers affiliated with various branches of the U.S. military.
• VA loans are available without down payments or private mortgage insurance.
• Home loan limits vary significantly between the VA and FHA programs.
• Homeowners approved for VA loans must pay funding fees to reduce the burden on taxpayers.

If you're eager to buy a house but worried about your ability to qualify for a conventional mortgage, your best bet may involve FHA or VA financing. Look closely at the eligibility standards for these programs to determine whether you qualify. It's also worth your while to examine the long-term financial implications of each option. A little extra research up front could make a world of difference down the road.