Everything you need to know about government-backed mortgages and loans – Forbes Advisor
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Government-backed mortgages may be easier to obtain than conventional loans. This may make it a good choice if you have a lower income, don’t have perfect credit, or can’t afford a large down payment. Some borrowers might also benefit from a lower interest rate on a government-backed loan than they would get with a conventional mortgage.
There are several government programs to consider if you’re looking for a mortgage, so it’s important to understand how each works when comparing your options. Here’s what you need to know about government-backed mortgages and loans.
What are government loans?
Government home loans are mortgages issued by private mortgage lenders and insured by the federal government. Several government agencies offer mortgage programs, including the Federal Housing Administration (FHA), the United States Department of Agriculture (USDA), and the Department of Veterans Affairs (VA).
Since the federal government guarantees these loans, there is less risk to the lender if a borrower defaults. This is why government guaranteed loans come with more lenient requirements than conventional mortgages. For example, you might qualify with a:
- Small deposit: Depending on the type of loan you are applying for, down payment requirements can be as low as 0% to 10% of your loan amount. This is far less than the traditional 20% needed for a conventional loan to avoid private mortgage insurance (PMI).
- Lower credit score: You will generally need a credit score of at least 620 to get approved for a conventional mortgage. Government guaranteed loans, on the other hand, usually have lower credit score requirements. For example, you might qualify for an FHA loan with a credit score as low as 500, although having a score that low may require a higher down payment. USDA and VA loans do not have a specific minimum, although lenders often set their own minimums.
- Higher debt-to-income ratio (DTI): Your DTI ratio is the amount you owe in monthly debt payments relative to your income. Many mortgage lenders require your DTI ratio to not exceed 43%, but others allow more leeway. For example, government-backed loans typically allow a maximum DTI of 41% for VA loans and 43% for FHA and USDA loans. But you could still qualify for an FHA loan with a DTI ratio as high as 57%, although this is decided on a case-by-case basis.
Also keep in mind that government-backed loans are considered non-conforming loans, meaning they operate outside the standards set by Fannie Mae and Freddie Mac for conventional mortgages. Also, although Fannie Mae and Freddie Mac are both government-sponsored businesses, they are not a source of government-backed loans. Instead, these entities are privately owned and purchase mortgages from lenders so that those lenders have more funds to continue issuing mortgages, which ultimately supports the nation’s residential mortgage system.
How do government backed mortgages work?
The process of getting a government guaranteed mortgage is similar to applying for a conventional loan – you will still work directly with a mortgage lender who will fund the loan if you are approved. However, unlike conventional mortgages where the lender is at risk if a borrower defaults, government guaranteed loans are insured by a federal agency, which protects the lender.
Although government-backed mortgages are generally easier to obtain, you will still need to meet the credit, income, and financing requirements set by the lender as well as the government agency guaranteeing the loan. It is also common for government programs to restrict eligibility to certain backgrounds. For example, VA loans are only available to military households, and USDA loans require you to live in a rural area.
Types of Government Backed Mortgages
There are a few main types of government-backed mortgages, including:
FHA loans are designed to help low-to-moderate income borrowers qualify for home financing. They also come with a lower credit score and down payment. It is possible to qualify with a median FICO score as low as 500, although most FHA lenders require a score of at least 580.
Another important advantage of FHA loans is the low down payment requirement. The minimum down payment for an FHA loan is generally only 3.5% of the loan amount if you have a credit score of 580 or higher. If you have a score lower than this, you will probably need to deposit at least 10%.
Keep in mind that all FHA loans require you to pay a Mortgage Insurance Premium (MIP). However, if you put at least 10% down payment, you will only have to pay it for the first 11 years of your loan; otherwise, you will pay it for the duration of your refund. Note that mortgage insurance on an FHA loan includes an initial MIP of 1.75% of your total loan amount, plus an annual MIP of 0.45% to 1.05% of the loan amount, depending on the amount of your loan, the repayment term and the loan-to-value ratio. (LTV).
Related: FHA Loan Calculator
USDA loans are available to low- to middle-income borrowers who live in rural areas, which the USDA defines as small communities with populations under 35,000. To qualify for a USDA-guaranteed loan, i.e. it is financed by a private lender, your income cannot exceed 115% of the median household income in the area. Direct loan limits funded by the USDA itself can be as low as 50% of median income in some areas.
Although USDA loans do not have a specific minimum credit score requirement set by the USDA, you will need a score of at least 640 to qualify with most USDA mortgage lenders. These loans also do not require a down payment.
Note that you will need to purchase two types of mortgage insurance for a USDA loan, which will cover your payments in case you lose your job and cannot pay. These include 1% of your loan amount due at closing as well as 0.35% of your original loan amount per year for the life of the loan.
Related: USDA Mortgage Calculator
VA loans are available for military service members, veterans, and their surviving spouses. Like USDA loans, VA loans do not require a down payment and have no specific minimum credit score, although some VA mortgage lenders may require a score of at least 580.
You also won’t have to worry about mortgage insurance with a VA loan, no matter how big your down payment is. However, a one-time VA financing fee is due at closing and depends on your down payment amount. While this fee may be waived in limited cases, such as for veterans with service-related disabilities, you can expect to pay:
- 2.3% ($2,300 per $100,000 borrowed) for down payments less than 5%
- 1.65% ($1,650 for every $100,000 borrowed) for a down payment of 5% to 10%
- 1.4% ($1,400 for every $100,000 borrowed) for down payments greater than 10%
Note that this fee will increase if you take out additional VA loans.
To participate in the VA Loan Program, you must obtain a Certificate of Eligibility (COE) from the VA. You can apply for it online or by mail, or your VA lender can apply for it for you.
Related: FHA vs. Conventional Loans Vs. VA Loan
Native American Direct Loans (NADL)
The VA also oversees the NADL program, which sponsors loans to help buy, build or improve homes on federal trust land. You may qualify for this type of loan if you are a Native American veteran or a non-Native American veteran who is married to a Native American. You will also need to provide a COE and meet other VA loan requirements.
As with other VA mortgage programs, you will pay a one-time financing fee at closing. This is 1.25% for purchase loans and 0.5% for mortgage refinances.
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