Do you know the difference between a conventional mortgage and a government-backed home loan such as an FHA loan, VA mortgage, or USDA home loan? There are two big areas some are concerned with; those areas are down payments and mortgage insurance.
We’re looking at the differences between conventional and government-backed home loans with this in mind since a home loan down payment and the insurance you’ll need over the course of the loan are important costs to be mindful of.
A conventional loan (available as a conforming loan or a non-conforming loan) is a mortgage that is not backed by the federal government. These mortgages usually require private mortgage insurance. That is, unless a down payment meeting lender requirements is made. That down payment is typically 20 percent of the adjusted value of the home.
Conventional mortgages are not constrained by or guaranteed by a government program such as the FHA or USDA, and as such typically may have higher interest rates. Conversely, there may be fewer restrictions on what you can do with the home you buy with a conventional loan.
Occupancy Requirements May Vary With Conventional Loans
What does this mean? Typically for a government-backed mortgage (USDA, FHA, VA) you cannot purchase a home that is not primarily residential in nature, you cannot use the property to run an Airbnb. You cannot use the home as a vacation property. It cannot be used as an occasional-occupancy residence. Government loans typically require occupancy.
Conventional new purchase mortgages (as opposed to refinance loans) may also require occupancy, but such loans would be based on lender standards, not the regulations of the FHA, VA, USDA, etc.
VA Mortgage Loans
VA home loans have one major financial advantage over all other mortgages except USDA home loans; they usually have no required down payment of any kind. The rules for VA mortgages forbid any type of penalty for early payoff of the mortgage.
That cannot be said of all conventional home loans.
There are some instances where a VA borrower would have to pay out-of-pocket in a downpayment-like manner but these are usually cases where the sale price is higher than the appraised value or adjusted value of the home and the borrower wants to buy anyway.
Saving Money Up Front
No down payment means big savings up front, but the catch with a VA home loan is that only qualified members of the U.S. military, certain surviving spouses of service members who died as a result of military service, and veterans may apply for and be approved to use a VA mortgage.
But if you DO qualify for a VA home loan, chances are good that you will save more up front on the transaction than with a conventional loan or even an FHA mortgage. Add to that the fact that there is no VA-required mortgage insurance and you can see how a VA loan would be an advantage.
FHA home loans require both a down payment and mortgage insurance. But the down payment is very low compared to conventional mortgages. FHA home loans have a minimum down payment requirement of 3.5% of the adjusted value of the property.
FHA loans do not require private mortgage insurance, but they do require a mortgage insurance payment up front as part of your closing costs and a monthly premium that is payable for either 11 years or the lifetime of the loan.
Similar to VA mortgages, FHA loans require the lender to allow early payoff of the mortgage without a financial penalty.
USDA Home Loans
USDA loans and VA mortgages share one important feature in common–there is no down payment requirement in most cases. Like FHA loans, USDA mortgage loans require a type of mortgage insurance but does not require private mortgage insurance. Borrowers who apply for USDA mortgages should expect to have to pay an insurance premium on their loans like FHA mortgages.
No down payment expenses up front is known as 100% financing in the lending world. Some conventional mortgages may offer you reduced costs or lower down payment options. That option may come in exchange for a higher interest rate with other types of lending, but this is not how USDA mortgages work.
This is, like a VA loan, a no-money-down home loan that keeps interest rates low in the service of borrowers who cannot afford a conventional home loan or the down payment requirements.
The Fine Print
What’s the catch? VA mortgages are only for service members and other qualified borrowers, but USDA loans are not military-based. However, USDA mortgages ARE considered need-based loans and your household will be subject to an income cap in order to qualify for the home loan.
Joe Wallace specializes in personal finance, military affairs, and consumer protection topics. Since 1995, his work has appeared on Air Force Television News, The Pentagon Channel, ABC and a variety of print and online publications. He is a 13-year Air Force veteran and collects unusual vinyl records, which gives him an excuse to write the vinyl blog Turntabling.net.