If you’re new to the homebuying process, chances are you’re wondering what the term “government backed mortgage” really means. Before we get into what it is, let’s touch on what it is not. A government backed mortgage is not a guarantee that you will be approved just because the federal government is backing the loan. Government backed mortgage programs are not the same as conventional loan programs. Conventional mortgages are of much greater risk to a lender, whereas government backed mortgages are guaranteed to be paid by, you guessed it, the federal government should the borrower ever default on the loan.
In today’s market, conventional loans are typically approved based on Fannie Mae or Freddie Mac standards. Nearly 2/3 of all home loans approved these days are conforming conventional loans. The other third falls under the category of government backed mortgages. Although a small percentage of home loans are known as portfolio loans, where the lender does not intend to sell the mortgage.
The three most common types of government baked loans are FHA loans, USDA loans, and VA loans. These loans are often seen paired with the word guarantee. Don’t confuse the word as a guarantee that you’ll be approved for a loan. The word guarantee is used to ensure the lender will be compensated should the borrower default on the loan.
FHA loans are insured by the Federal Housing Administration, and are designed for lower-income homebuyers. These loans will compensate the lender for the outstanding balance on the loan. In order to receive an FHA loan, the borrower will have to pay two specified fees; an upfront fee, and an annual fee to be paid monthly along with regular monthly mortgage payments. One of the appeals of an FHA loan is that they offer up to 97.5% financing and can be issued to borrowers with poor credit.
USDA loans are backed by the United States Department of Agriculture, and offer 100% financing to homebuyers in specified, rural areas of the United States. These loans will compensate the lender in full should the borrower default on the loan. Like the FHA loan program, this program also has an upfront fee and an annual premium. There are no credit score minimums for USDA loans, although most lenders will prefer a credit score of about 640.
The Department of Veteran Affairs is the organization that backs VA loans. VA loans are designed to help U.S. veterans and active duty service members. Widowed spouses of service members may also be eligible for VA loans. The Department of Veteran affairs guarantees the lender 25% of the loan amount if it goes into default. Those seeking a VA loan will have to pay a fee to the Department of Veteran Affairs.