Before we answer that question, let’s make sure we understand what VA home loans are and why the Department of Veterans Affairs created them.
VA loans are offered by banks, mortgage companies and other private lenders for active service members, veterans, and their eligible surviving spouses. A VA loan doesn’t require a down payment and it comes with a low interest rate and limited closing costs.
VA loans came into existence when World War II was winding down as a way to help returning servicemen and women buy a home when they might otherwise have not been able to afford a down payment or apply a top-notch credit rating to the purchase. VA home loans were, and still are, a way to show the government’s appreciation for the sacrifice and service provided by the nation’s soldiers, sailors, and members of the other military branches.
Bottom line: They make buying a home more affordable than most conventional mortgages would. One of the reasons they’re less expensive is that the VA guarantees a portion of the loan, which minimizes the risk to the bank or mortgage company offering the loan. That results in more favorable terms for the vet, military member or spouse in the market for a new home.
And that leads us to the answer we postponed a little earlier: No, a VA loan doesn’t require Private Mortgage Insurance (PMI) because the VA guarantee protects the lender.
Which, naturally, raises the question in the next section’s headline.
What Is Private Mortgage Insurance?
Basically, Private Mortgage Insurance (PMI) is how the lender protects itself when it makes a conventional loan or FHA home loan. The bank or mortgage company requires you to buy insurance against the possibility that you won’t or can’t make your payments on time. If you don’t, your PMI reimburses the lender for your failure to meet the loan obligation.
In most cases, you don’t have much of a choice in the matter. The lender arranges your PMI with a private insurer and makes it a part of the deal you agree to before you get the loan. You pay the cost of the PMI in addition to other charges that come with your loan.
The point is, you’re paying for insurance that insulates the people loaning you the money, not you. One way to think about it: You pay a financial penalty for your inability to make a significant down payment on a home. And even with PMI, you can still lose your home through foreclosure.
With a conventional loan, you’ll pay for PMI every month until you reach 20% equity in your home. With an FHA loan, the PMI payments stay with you for the duration of the loan term.
If it sounds expensive, well, it can be. But there are a handful of less onerous features to Private Mortgage Insurance. First, PMI generally isn’t required with a conventional loan if you can make a down payment of 20% or more. Second, in many cases you can cancel your PMI when you’ve paid down your mortgage to an agreed-upon amount.
And third, your lender should give you some options for how to pay the PMI premiums. The most common way is monthly, as an addition to your regular mortgage payment. But if you can, you might be allowed to pay a one-time, up-front premium at closing to cover the total cost, or combine an up-front premium for a chunk of the total cost that results in a lower monthly sum added to the mortgage bill.
The trouble with an up-front premium payment is that you might not get a refund on it if you move or refinance your home.
How Much Does PMI Cost with a Conventional Loan?
How much you’ll pay for Private Mortgage Insurance depends on a number of factors, including the size of your down payment, the amount of your mortgage, the length of the term of your loan and your credit score. The private insurer will use those elements to evaluate the risk that you might default on the loan. The higher the risk, the more you’ll pay for PMI.
Generally, the cost will be between 0.5% and 2% of your loan balance per year. If you’re paying monthly as part of your regular mortgage bill, you can expect the charge to be somewhere between $30 and $70 per month for every $100,000 you’ve borrowed. The PMI for a $300,000 loan, then, could cost you anywhere from $90 to $210 every month. Because you’re obligated in most cases to pay it monthly for a number of years, it adds up.
Remember, though, that Private Mortgage Insurance is in play only for conventional loans and FHA loans. It isn’t required when you take a VA home loan, which is a darn good reason to check into your VA loan eligibility if you think you might qualify. Surely, you can find a good use for the money you’ll save every month by not paying to protect your lender.
But …
VA Loans and VA Funding Fee
There always seems to be a ”but,” right? Here’s this one: VA loans come with their own extra toll called a VA funding fee. It, too, can feel expensive, though the funding fee you’ll pay with a VA loan should be less costly than Private Mortgage Insurance for a conventional loan. And at least from the borrower’s point of view (that’s you!), the reason you’re required to pay it is probably more palatable. (More on that coming up.)
A VA funding fee might seem like PMI in that it adds to the cost of your loan. As with PMI, you pay a VA funding fee when you close on your home. In most cases, you won’t be able to avoid it, although there are some exemptions, which we’ll list in a bit.
Down payments come into play for both PMI and VA funding fees. A down payment of 20% or higher on a conventional loan will eliminate PMI. We’ve mentioned that you can get a VA loan without a down payment, but that doesn’t mean you can’t put some money down. If you put at least 5% down with a VA loan, you’ll reduce the amount of your VA funding fee.
What Are VA Funding Fees?
Simply put, a VA funding fee is a one-time payment on a VA-backed or VA–direct home loan, due as part of the closing costs, along with other expenses such as a loan origination fee, title insurance, a recording fee and a VA appraisal fee.
It can be paid in full at closing, or it can be rolled into the loan and paid over time.
The most obvious situation in which you’ll need to pay a VA funding fee is when you take out a VA loan to buy a home. But funding fees are required as part of VA loans to build, improve, or repair a home, too, as well as to refinance a mortgage.
In every case, the VA funding fee is a small percentage of the total loan amount.
How Much Do VA Funding Fees Cost?
As of April 7, 2023, the Department of Veterans Affairs cut its rates for funding fees from 2.3% to 2.15% on first-time loans with a down payment of less than 5%. If you make a down payment of between 5% and 10% of the loan amount, the funding fee rates decreased from 1.65% to 1.5%. And for a down payment of 10% or more, the rate went from 1.4% to 1.25%.
That means the VA funding fee for a VA home loan of $200,000 with no down payment would be $4,300, if you are a first-time VA loan borrower. Before April 7, 2023, it would have been $4,600.
Two things to note: 1) The funding fee applies to the loan amount, not the purchase price of the home, and 2) The rates of VA funding fees are higher for borrowers who are using a VA loan for the second time and all times thereafter, though those rates were also reduced in April 2023.
Why Do VA Loan Borrowers Pay a VA Funding Fee?
This is the part that should make servicemen and women feel better about paying a VA funding fee rather than buying Private Mortgage Insurance that only protects the company making the loan. It’s true that you get a VA loan from a private lender such as a bank or a mortgage company, just as you would with a conventional loan. But the funding fee you pay with a VA loan goes to the VA rather than to the lender or an insurance company.
The VA uses funding fees to support its VA loan program. They’re a part of the way the VA guarantees its loans without requiring Private Mortgage Insurance. In essence, the VA funding fee makes it possible for other service members, veterans, and their spouses to take advantage of the benefits of VA loans.
Is a VA Funding Fee Required?
The answer to that question is yes, in most cases. But there are exceptions.
You can be excused from paying a VA funding fee if you meet one of these criteria:
- You’re receiving VA compensation for a service-connected disability.
- You’re eligible to receive VA compensation for a service-connected disability, but you’re receiving retirement or active-duty pay instead.
- You’re receiving Dependency and Indemnity Compensation (DIC) as the surviving spouse of a veteran.
- You’re a service member who has received a proposed memorandum rating before the loan closing date that says you’re eligible to get compensation because of a pre-discharge claim.
- You’re a service member on active duty who, before or on the loan closing date, provides evidence of having received the Purple Heart.
Private Mortgage Insurance vs. VA Funding Fee
Here’s a handy-dandy way to compare PMI and a VA funding fee.
Private Mortgage Insurance:
- Mandatory on conventional loans and FHA loans unless you make a down payment of 20% or more.
- Cost generally ranges from 0.5% to 2% of the amount of your loan, but the rate could be higher.
- Billed along with your monthly mortgage for most conventional loans until you reach 20% equity in your home, which usually takes at least five years.
- For an FHA loan, it’s billed along with your monthly mortgage for the duration of the loan.
- Purpose is to protect the lender against the possibility that you will miss payments or default on the loan.
VA funding fee:
- Mandatory for VA loans and VA home loans, with exceptions for borrowers with a service-connected disability, a Purple Heart, or other criteria.
- Cost is 2.15% of the loan amount for first-time VA loan borrowers whose down payment is less than 5%.
- One-time payment at the time of closing unless the borrower chooses to roll the cost into the loan and pay it off over time.
- Money goes back to the VA to help continue the program for future borrowers in the VA home loan program.
Read More About VA Loans and Eligibility
A VA funding fee isn’t inconsequential. It’s an extra charge on top of the VA loan you’re taking to buy, build, repair or improve your home, or refinance your mortgage. As you have seen in this article, though, a VA funding fee has fundamental advantages over the necessity of buying Private Mortgage Insurance for a conventional or FHA loan that protects your lender, not you.
But if you’re still concerned about the expense of a VA funding fee, you should weigh that concern against the many other benefits of using a VA loan to obtain a home. Among them:
- No minimum down payment required.
- Lower interest rates and other favorable loan terms.
- Limited closing costs.
- Eligibility approval with a higher debt-to-income ratio than conventional loans allow.
- No minimum credit score required by the VA (although it isn’t uncommon for the lender to want a FICO score of at least 580).
- Ability to use a VA home loan numerous times.
You should research all of your options. If you are eligible for a VA loan, here are a couple of stories that might help.
- Do You Pay Closing Costs With a VA Loan?
- Can You Have Multiple VA Loans?
