When you’re applying for a mortgage, your mortgage banker will likely offer you a handful of different loan options — among those, you might find yourself eligible for a government-insured loan. In the world of mortgages there’s a dividing line between conventional loans and government-insured (also known as government-backed) loans.
As the name suggests, a government-insured loan is “backed” by the government to guarantee repayment to the bank, should you default on your mortgage payment.
Conventional loans aren’t backed by the government, meaning there’s no guarantee for the lender if you, as the borrower, are unable to repay, resulting in stricter qualifying criteria. The main difference between the two categories is that conventional loans are those that conform to Federal Housing Finance Agency (FHFA) guidelines, which are set every year — something government-insured loans do not do. You can read more about conventional loans in depth on the Atlantic Bay blog.
For some, a conventional loan is not an option due to lack of income, down payment requirements, or issues with credit — which makes government-insured loans favorable choices in those scenarios. Here’s the breakdown of the three government-backed mortgages:
Government-insured loans are backed by either the Federal Housing Authority, which provides a loan option called FHA, the U.S. Department of Veterans Affairs, which has an option called the VA loan, or the U.S. Department of Agriculture, which provides a mortgage option called the USDA loan.
First off, not every lender can offer FHA loans. A lender has to be approved by the FHA to offer FHA-backed mortgages. These loans have more lenient requirements when it comes to credit and down payment, compared to some of other loan types available — 3.5% down payment to be exact. It’s available for anyone as long as they’re getting the loan to purchase or refinance a primary residence and meet other loan requirements. FHA loans tend to be more popular with first-time homebuyers, and as a result, is often referred to as the “first-time homebuyer” loan.
This option is available to veterans, Reservists, active duty military, or even surviving spouses of veterans. The VA loan is typically considered the best loan option out there because it requires no down payment, no private mortgage insurance, flexibility with credit scores, and more.
These loans are great if you’re interested in purchasing a home in a smaller, rural or eligible suburban community, since USDA loans provide the opportunity to own a home in those areas at affordable interest rates. “Smaller” or “rural” doesn’t necessarily mean “farmhouse”, it just means the neighborhood has to be under a certain population that qualifies it as “rural” — some are surprisingly suburban.
As a future homeowner, what should you consider when determining if government-backed loans are something you might be interest in?
For many, homeownership isn’t accessible due to financial limitations or subpar credit. From a lender’s perspective, the risk of repayment (or rather, risk of not being able to make payments) is a primary reason that loans are not issued to lower-income applicants.
A government-insured loan, however, removes the risk of repayment because it’s secured by the government. Therefore, government-insured loans make homeownership accessible to more populations that otherwise wouldn’t be approved for a conventional loan. Upon assessing a loan application, lenders don’t typically approve a conventional loan for a buyer that has a higher debt-to-income (DTI) ratio. However, FHA loans, for example, are accessible for those with higher debt-to-income ratios.
A down payment is often required by a lender in order to ensure repayment. As mentioned above, having the government back a loan alleviates some risk for the lender and allows them to offer a loan with lower down payment requirements. FHA requires as little as 3.5% down, whereas USDA and VA require no down payment at all.
Not everyone has a perfect credit score, that’s why government-insured loans can be fitting for those individuals who may have less-than-desirable credit scores. A conventional loan typically requires a credit score above 620. But FHA and VA loans are available for homebuyers with credit scores of at least 580.
Purchasing a home through a government-insured loan can open a lot of financial doors for borrowers. As a homeowner, you’ll start building equity and credit — which will help your financial portfolio moving forward. For many people, the lack of assets and credit history is a recurring obstacle that stands in the way of important purchases like buying a car, qualifying for other loans and more.
Most government insured loans have a limit to the amount that you can borrow.
Upon first thought, you may consider this to be a negative factor, however, these limits are calculated based off of a percentage of your total income, taking your debt-to-income ratio into consideration. This can be helpful because it ensures you’re purchasing a home within your financial means. Such structure not only helps make homeownership a reality, but it sets you up for continued financial success and growth that you can afford.
To learn more about other mortgage options and the overall loan process, visit the Atlantic Bay blog or talk to a mortgage banker.