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Buying a house with a mortgage is a costly endeavor, and it's not always easy to get approved. Some prospective homebuyers may be able to find fewer costs and more lenient borrowing criteria with one of the three government-backed loans. Government-backed mortgages are a type of mortgage loan that are insured by an agency of the federal government.
Here's what to know about how government-backed mortgages work, the types available and whether they might be a good fit for you.
What Are Government-Backed Mortgages?
Government-backed mortgages are loans obtained through a private lender, such as a bank, but insured by one of three federal government agencies: the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA) or the Department of Veterans Affairs (VA).
Because the government backs these loans, lenders can take greater risks by allowing lower credit scores and no or low down payments. However, they have different requirements and cost structures from conventional mortgages, the most common type of mortgage. A government loan may require upfront fees and mandatory mortgage insurance, for example.
Learn more >> What Credit Score Do I Need to Buy a House?
How Do Government-Backed Mortgages Work?
Government-backed loans are a partnership between federal agencies and private lenders, with the backing agency insuring the loan should the borrower default. The government places strict requirements on eligibility and property type, but they leave other criteria—like interest rates, and in some cases, credit scores—up to lenders.
Not all lenders choose to participate in these programs. For those that do, the loan process is similar to getting a conventional loan, but borrowers face additional requirements along the way, like having a government-approved appraiser ensure the property meets minimum standards. Each type of government-backed mortgage also has its own fee structure. All three require an upfront fee for most borrowers, and FHA and USDA loans require ongoing monthly fees.
Types of Government-Backed Home Loans
The three types of government-backed loans are each designed for certain borrowers, and you may be eligible for more than one. Here's what you should know about each.
FHA Loan
FHA loans often have lower down payments and closing costs than conventional loans, with more lax credit criteria. They're geared toward low- and moderate-income households, especially first-time homebuyers.
FHA loans are more accessible than USDA and VA loans because they aren't limited to those who have served in the military or who want to move to specific areas. The trade-off: You'll pay monthly mortgage insurance premiums for the life of the loan. With a conventional loan, on the other hand, those typically drop off once you reach 22% equity. The home must also be appraised by an FHA-approved appraiser, it must meet minimum property standards and it can only be used for a primary residence.
- Credit score: A credit score of 580 can qualify borrowers for maximum financing, or a 3.5% down payment. For credit scores of 500 to 579, 10% down is required. Credit scores below 500 aren't eligible.
- Down payment: 3.5%
- Other requirements: The primary drawback of an FHA loan is its mortgage insurance requirement. You'll typically pay an upfront premium of 1.75% of the loan amount, plus an annual premium of 0.15% to 0.75% (this recently decreased to make homebuying more affordable). You can't drop this monthly fee on an FHA loan without refinancing—unless you originally put down 10% and waited 11 years after closing. There are limits on mortgage size, which vary by location.
Learn more >> How to Qualify for an FHA Loan
VA Loan
VA loans can be used to buy or build a home, make a simultaneous purchase and renovation or make energy-efficient updates. They're the most restrictive government-backed loans in terms of accessibility. To qualify, you must be an active-duty service member, a veteran, an eligible spouse of a veteran, or a U.S. citizen who served in the armed forces of a government allied with the U.S. during World War II.
VA loans don't have monthly mortgage insurance premiums, but they do charge a hefty upfront funding fee to many borrowers. The VA states that their loans have fewer closing costs than conventional loans. However, if you plan to make an optional sizable down payment and have good credit, the funding fee can make a VA loan more expensive than a conventional mortgage.
The fee ranges from 1.25% to 3.3% of the total loan amount and varies by down payment size and whether or not it's your first time using a VA loan. This fee is waived for some borrowers, such as those receiving VA compensation for service-connected disabilities. However, lenders may charge their own 1% origination fee on top of VA fees.
- Credit score: The VA doesn't set a minimum credit score, but lenders might. It's common to see minimums between 620 and 640, though some will accept scores at 580 or even lower.
- Down payment: 0%
- Other requirements: You must apply for a Certificate of Eligibility to prove to lenders that you qualify. The home must be approved by a VA-approved appraiser who will ensure the home meets certain basic property condition standards.
Learn more >> How Does a VA Loan Work?
USDA Loan
USDA loans are backed through the agency's Rural Development Guaranteed Housing Loan Program. They're limited to low- and moderate-income borrowers buying property in a rural or eligible suburban area—dense urban areas are excluded. While they require an upfront fee and monthly mortgage insurance premiums, USDA loans are overall often cheaper than FHA loans. There are a few different types of USDA loans, but with a standard USDA-guaranteed loan from a private lender, no down payment is required.
- Credit score: There's no set credit score requirement, though lenders need evidence you can manage payments and debts.
- Down payment: 0%
- Other requirements: USDA loans are only for owner-occupied primary residences. A borrower's income can't exceed 115% of the median household income for their county. Like FHA loans, you'll pay a one-time upfront fee, called a guarantee fee, plus a monthly fee for the life of the loan. The upfront fee can't exceed 3.5% of the total loan amount, but it's typically 1%. There's also an annual fee of up to 0.5% of the unpaid principal balance, which is distributed across your monthly payments. You might be able to finance these fees as part of your loan.
Pros and Cons of Government-Backed Mortgages
Government-backed mortgages can be hugely beneficial and make buying a home more accessible, but they're not for everyone and aren't always the best deal.
Pros
- Low or no down payments: FHA loans offer down payments of 3.5%, and VA and USDA loans require nothing. While some conventional loans offer low down payments, it's rare to find one lower than an FHA loan.
- More lenient credit criteria: If your credit score needs improvement or you have some blemishes on your credit report, you might get approved more easily with a government-backed loan than a conventional one.
- Flexible with funding: Most loans don't allow, or limit, using money from family, an employer or a charitable organization as a gift as a down payment. FHA and USDA loans don't have these restrictions.
Cons
- Strict eligibility requirements: Not just anyone can qualify for a government-backed loan. For example, USDA loans are restricted to owner-occupied primary residences in rural locations and carry income limits.
- Limited to specific property types: It's common to find restrictions on things like property location, type, occupancy, value and safety and security controls.
- Not always the best deal: If you have decent credit and some down payment money saved, it's possible you'll get a better deal with a conventional loan with fewer upfront and ongoing fees. Get a quote for both loan types to compare.
Learn more >> Types of No or Low Down Payment Mortgages
Frequently Asked Questions
It varies by loan. USDA loans can be used to build, improve or rehabilitate an eligible property.
While traditional FHA loans don't cover remodeling, there's a separate loan called the FHA 203(k) Rehab Mortgage that lets you borrow money to buy and renovate a home, or remodel your existing home.
VA purchase loans can be used to buy a property and make improvements to it at the same time. It can only be used to remodel existing homes to improve energy efficiency. The VA also offers cash-out refinance loans that you can use to take out home equity and use it on home improvements.
Government loans aren't hard to get, but their eligibility requirements may be difficult to meet. They typically offer more leniency with credit history, but due to restrictions on borrower income, location, property type or military service, not everyone can get them.
Closing costs vary by loan type, terms, lender and more. There are also government limits on the types and amounts of fees lenders can charge, which can mean lower closing costs than conventional loans.
That's not to say government-backed loans always have lower closing costs. With steep upfront fees, it's possible they'll come out pricier for some homebuyers or about the same. The key difference: government-backed loans require far less, or nothing, down—so you'll have more cash handy for closing costs, and many let you roll some closing costs into the loan.
Get Your Credit Mortgage-Ready
Regardless of which mortgage you choose, it's crucial to check your credit score and credit report beforehand. Improving your credit for a mortgage can take some time, so review it at least three to six months before applying so you have time to make improvements.