For many Americans with dreams of buying a home, certain financial hurdles can make it seem impossible. For example, many cannot afford to cover high down payments or simply don’t have the credit profile that lenders are looking for in a mortgage applicant.
Luckily, there are a variety of options out there for people who cannot qualify for conventional loans, whether it be a 15- or 30-year fixed rate mortgage or an ARM (adjustable rate mortgage). These options are all backed or insured by government agencies, namely the US Department of Agriculture (USDA), Department of Veterans Affairs (VA) and Federal Housing Administration (FHA), which is part of HUD (Dept. of Housing and Urban Development).
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While government-backed mortgage loans offer financing options for qualified applicants, there are key distinctions that determine which mortgage is the right choice for a prospective homebuyer. Here is a breakdown of all three.
The most popular of the three major government-backed mortgages, an FHA loan is designed for consumers with lower credit scores and down payment funds, making it an attractive option for first-time homebuyers. While the loan is insured by the FHA , it is funded by an approved mortgage lender. Still, an FHA loan is a lot more accessible than a conventional loan, as borrowers with a credit score as low as 500 may get approved.
The minimum down payment for an FHA loan is 3.5%, but a figure that low would require a credit score of at least 580 (by comparison, the minimum credit score for a conventional mortgage is roughly 620). To get an FHA loan with a credit score in the 500-579 range, a borrower would have to put down at least a 10% down payment. While lenders accept low credit scores, other factors that may impact ultimate approval include verifiable income and assets, consistent employment record (typically two years), debt-to-income ratio, and payment history (e.g., rent and debts).
Since the FHA is insuring the loan, by compensating the lender in the event of a borrower defaulting on their mortgage, FHA borrowers are required to pay a mortgage insurance premium (MIP) at both closing and during their monthly mortgage payments. The upfront MIP fee is 1.75% of the loan amount, while the Annual MIP is a monthly payment and ranges based on the down payment, loan amount, and loan term.
Similar to an FHA mortgage, a USDA mortgage (backed by the department’s Rural Housing Service) is intended for low-to-moderate income homebuyers. It is more narrow in its availability, however, as the loan is only intended for homes in eligible rural areas (defined by USDA), as opposed to dense urban and suburban areas. Unlike FHA, RHS both lends directly to qualified borrowers via approved lenders and guarantees the loan up to 90% of the outstanding debt owed, in the event of a default.
Another big difference with a USDA mortgage is there is typically no down payment required. While this may seem like a more worthwhile option for those buying in eligible regions, it should be said that USDA mortgages require higher credit scores from lenders, with the magic number usually being 640. Applicant’s with a credit score below 640 may still be eligible, as the USDA does not set a minimum credit score requirement, however the file will be manually underwritten and subject to stricter guidelines. Prospective homebuyers can check the USDA website for more info, including location eligibility.
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As for mortgage insurance, borrowers have to pay both upfront at closing (1% of loan amount) and on an annual or monthly basis (0.35% of loan amount), which are known as Guarantee Fees.
As the name implies, VA mortgages are available for US veterans, as well as active-duty service members and certain eligible spouses. There is no minimum credit score or down payment requirement set by the VA, although the VA requires lenders to review the entire loan file, which may result in a requirement depending on the situation.
With mortgage insurance, a VA mortgage differs from the FHA and USDA options in that it only requires one upfront payment known as a Funding Fee, the percentage of which varies depending on several factors (e.g., down payment, and whether it’s the borrower’s first VA loan). A VA mortgage borrower can also choose to have the fee rolled into their loan balance, although it will increase their monthly payment. The VA guarantees a portion of the loan in the event of a borrower default, generally 25% of the loan amount.
For homebuyers that can’t qualify for conventional loans, whether it be the down payment requirement or their credit, government-backed mortgages provide a crucial alternative option. Still, it’s important to understand that applying will involve dealing with private mortgage lenders that are not affiliated with the government. Depending on an applicant’s credit, down payment amount, loan amount, and other factors, the rates and approval for government-backed loans may vary.
For prospective homebuyers interested in exploring their options, Fiona allows you to compare offers from top providers based on rate, loan type, and other filters.
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