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Is a VA loan the best option? Pros, cons and alternatives to consider

Bankrate logo Bankrate 9/28/2021 Erik J. Martin
A single-family home in suburban Raleigh, North Carolina © AlexLinck/Shutterstock A single-family home in suburban Raleigh, North Carolina

If you're an eligible active-duty member of the military, veteran or surviving spouse, you have the ability to obtain a no-down payment VA home loan. This type of loan can be the most advantageous financing option for a home purchase or refinance, but there are pros and cons, and even other choices that might be better suited to your situation. Here are the benefits and drawbacks to consider.

What is a VA loan?

A VA loan is backed by the U.S. Department of Veterans Affairs (VA), but the loan itself, which can be used to purchase or refinance a home, isn't technically made by the government. Banks, mortgage companies, credit unions and other kinds of mortgage lenders offer them.

Not everyone qualifies for a VA loan, however; it is only available to veterans, active-duty military and their surviving spouses.

"To be eligible, you must do your time," explains Jimmy Kinley, a senior loan originator with Cherry Creek Mortgage in Highlands Ranch, Colorado. If you are on active duty, this means 90 consecutive days of service. If you are a National Guard or Reserve member, this means 90 consecutive days if you're activated, or six consecutive years if you aren't. If you are a veteran, the required service times vary based on when you served.

Illustration by Austin Courrege/Bankrate © Illustration by Austin Courrege/Bankrate Illustration by Austin Courrege/Bankrate

Advantages of a VA loan

A VA loan offers several perks over other forms of mortgage financing. For starters, you can purchase a home without having to make a down payment - and without needing to pay for mortgage insurance. With a conventional loan, you're required to put down at least 3 percent or 5 percent (depending on program), and if you put down less than 20 percent, you'll be on the hook for mortgage insurance.

What's more, you'll likely pay less interest with a VA loan, whether you choose a fixed-rate or adjustable-rate mortgage.

"The interest rate is typically about a half-percent lower than for a conventional loan," Kinley says.

Additionally, the VA doesn't impose a minimum credit score requirement on VA loan borrowers - although many mortgage lenders require a FICO score of 620 or higher regardless. For the lenders with a lower VA loan credit minimum, though, it could be easier for you to qualify. A VA loan also allows for a higher debt-to-income (DTI) ratio, which can help you qualify for a more expensive or larger home.

Plus, the closing costs associated with a VA loan can often be less than those for other loans, since the VA limits the origination fee a lender can charge to no more than 1 percent of the mortgage.

"The VA loan program does not have any prepayment penalties either, so the borrower can sell or refinance their loan at any time without penalty," adds Rob Killinger, senior loan officer with Danvers, Massachusetts-based Mortgage Network.

When it comes to refinancing, there is a VA cash-out refinance option where you can finance up to 90 percent of the value of your home; or, you can opt for an Interest Rate Reduction Refinance Loan (IRRRL) that enables you to reduce your interest rate through a streamlined process that doesn't require an appraisal. Both refinancing options might make a VA loan more appealing overall.

Thanks to more relaxed lending guidelines, you also won't need to wait as long to get a VA loan if you've been through a foreclosure, bankruptcy or short sale, says Kerry Sherin, consumer advocate for Ownerly, a home valuation company based in New York City.

"The waiting period for a VA loan can be up to half the time of a tradition loan: two years following a foreclosure, two years after a short sale unless all payments are on time - in which case there is no waiting period - two years after a Chapter 7 bankruptcy and 12 months after on-time payments while in Chapter 13," Sherin says.

Disadvantages of a VA loan

There's a flip side to every form of financing, and VA loans are no exception. While you won't pay for mortgage insurance with a VA loan, you will pay a funding fee at closing (although this fee can be financed into your loan).

If you're taking out your first VA loan and not making a down payment, the funding fee equates to 2.3 percent of what you're borrowing. If you do plan to put money down or have obtained a VA loan in the past, the fee can range from 1.4 percent (for first-time or repeat borrowers putting at least 10 percent down) to 3.6 percent (for repeat borrowers with no down payment).

Also, a VA loan can only be used for a primary residence, not for an investment or rental property or a second home or vacation home, says Chuck Vander Stelt, a real estate agent with Quadwalls in Valparaiso, Indiana. You might be allowed to purchase a manufactured home with a VA loan, but it must be attached to a foundation and pass a structural engineering examination.

Furthermore, with a VA loan, you aren't allowed to waive certain contingencies, such as the home inspection or appraisal, to make your loan offer more attractive to a seller. Some sellers, for that matter, are also less inclined to accept an offer with VA loan financing.

"In general, the unknowns and myths about VA home loans can create worry about the quality of the buyer and the seller's mind," Kinley says. "In a competitive market, some listing agents are telling sellers not to entertain VA offers."

Alternatives to a VA loan

A VA loan isn't your only choice of financing. Consider the following options, especially if you don't qualify for a VA loan:

  • Conventional loan - There is no funding fee on a conventional loan, and it can be used to purchase investment properties. The interest rates tend to be higher than for VA financing, however, and a down payment is also required, as well as private mortgage insurance if you're putting down less than 20 percent.
  • FHA loan - An FHA loan is also backed by the government and requires you to pay an upfront mortgage insurance premium, similar to the VA loan's funding fee. However, you'll also pay a monthly mortgage insurance premium, potentially for the duration of your loan, and your interest rate might be higher.
  • USDA loan - As with a VA loan, there is no down payment required for a USDA loan, but it is only for borrowers in designated rural areas. USDA loans also come with income restrictions, and the property must be a single-family home. Plus, only 30-year fixed-rate financing is available.

Is a VA loan the best option?

Even if you're eligible, there are times when a VA loan might not be your best choice.

"For example, if you are an eligible borrower who currently owns a home but wants to sell and purchase another primary home to yield a large down payment - 20 percent or more - from the sale that you can put toward your next home purchase, a VA loan may not make sense for your next property," Killinger says. "If you were to use a VA loan in this scenario, you may be required to pay the VA funding fee, whereas a conventional loan program would not require such a fee."

On the other hand, a VA loan offers special benefits that other financing does not.

"For instance, a qualified borrower could purchase a two- to four-unit property with a zero-down VA loan that they plan to live in instead of a single-family home," Killinger says. "In comparison, a conventional loan requires a minimum 15 percent down on a multi-unit property."

Still, the funding fee can be expensive. If you are planning to remain in your home for less than two years, it might not be worth it to pay this fee to get a VA loan.

"Also, if you are shopping for a home in a highly competitive market where sellers may look down upon VA financing, a VA loan may not be your best option," Vander Stelt says.

If you're still not sure whether a VA loan makes sense for you, consult closely with your loan officer, who can present all of the different mortgage options you qualify for and help guide your decision.

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