The VA Funding Fee vs. Mortgage Insurance
Pundits for the VA loan program often cite the lack of mortgage insurance as a major selling point of the program, while critics decry the Funding Fee as the uglier and less desirable cousin of mortgage insurance. Who’s right? We’re going to find out right here and now in the oh-so-epic, ultimate showdown between the VA Funding Fee and mortgage insurance. No punches will be pulled and no mercy will be given. To determine which really is superior, we’ll look at three factors: total cost, duration of pain, and the benefits provided. Strap on your seat belts and I hope you brought a fan because it’s about to get heated!
Round 1: Total Cost
In this first round, we’ll be looking at the total cost of mortgage insurance (henceforth referred to as PMI) and the VA Funding Fee (henceforth referred to as FF) to see which is really cheaper. So how much is PMI? It varies, but it usually won’t be more than 1% of the loan amount per year, and it will not usually be less than .5% of the loan amount per year. PMI is due monthly as part of your mortgage payment. If you’re on a conventional loan, once you’ve reached 20% equity in the home, you can go through the cancelation process to cancel your PMI. If you’re on an FHA loan, even after you’ve achieved 20% equity, you’ll continue paying PMI until you refinance to a conventional or VA loan. So, assuming it takes you five years to reach 20% equity (which could change depending on how large of a down payment you made), on a $200,000 loan, you’ll pay $10,000 in mortgage insurance, plus the $500 (ish) it costs to get your home re-appraised to determine the current value of your home. If you’re in an FHA, you can count on another $6,000 or so to refinance to a different loan program.
Now, for the FF, it is a one-time payment, but it can be as high as 3.3% if you’re using your VA loan benefits for a second or third time and are not making a down payment. However, since that’s for subsequent uses and not for first-time use, we’ll go with the high for first-time use, which is 2.15% of the loan amount. That means on a $200,000 loan you will pay just over $4,000 upfront though you can finance the amount into the loan if you wish. If you are to refinance, however, you’ll be required to pay it again, also at 2.15%, unless you refinance with an IRRRL (ask one of our loan officers for more info on that), in which case the FF is reduced to .5%. The lowest the FF can get on a new purchase is 1.25%.
Round Two: Duration of Pain
The results from round one seem fairly clear; unless you’re making almost a 20% down payment and are able to get a phenomenal PMI policy, the FF is going to be less overall cost. Now, we mentioned above that PMI is paid each month with your monthly payment either until you’ve hit 20% equity and applied for cancellation of the policy, or achieve 20% equity and refinanced out of an FHA loan to a conventional or VA loan. If you get a 30-year fixed mortgage like most people, it’s easily going to take 5 or more years to get to 20% equity, which means PMI will be affecting your budget for a long time. If you pay the FF all upfront, however, it hits your finances harder at first, but then no longer affects it at all unless you choose to refinance. It’s pretty clear that the FF wins this round as well.
Round Three: Benefits Provided
The FF is the entry fee to all of the benefits of the VA loan program: lower interest rates, better loan options (see VA hybrid ARM), cheaper and faster refinance options, plus protection in case you get underwater on your mortgage and are in a position where you need to do a short sale. There are a ton of benefits to the VA loan program, which you really should learn more about if you are VA eligible. So what benefits does PMI give you? Actually…it doesn’t really give you any benefit unless you count enabling you to purchase a home when you can’t afford a 20% down payment, which the FF also does. The benefit of PMI is for the lending institution, and it protects them in case you default on the loan. That’s why they require it of you; because a lack of a down payment is an indicator that you may not be financially ready for a home or that you might not be too serious about making regular payments.
Maybe we’re biased since we focus on offering VA loans, but it seems to us that the numbers don’t lie; the FF is better than PMI in pretty much every way that matters.