Government home loans: What are they and should you get one?

Homebuyers have an array of options when it comes to getting a mortgage. One option offered by many lenders is a government home loan. These mortgages are insured by the federal government, so if the borrower defaults, the government guarantees repayment to the lender.

In this article, we’ll explore several commonly used government home loans, looking at how each one works and evaluating features and benefits. We’ll then discuss the pros and cons of government-backed home lending products and some alternatives worth exploring.

Types of government home loans

Government home loans are insured by the federal government, but private lenders still make the loans.

FHA loans

A Federal Housing Administration (FHA) loan is a mortgage loan insured by the Federal Housing Administration. Private lenders make the loans, which are guaranteed and regulated by the government. The FHA has backed more than 46 million mortgages since 1934.

FHA loans require as little as 3.5% down if your credit score is above 580. If you have a credit score between 500 and 579, the down payment requirement increases to 10%. FHA loans require payment of mortgage insurance.

Other requirements include:

• Debt-to-income ratio of 43% or less
• Proof of employment and steady income
• Property must meet minimum standards
• Property must be your primary residence

Overall, FHA loans can be great for first-time homebuyers who have a smaller amount for a down payment or have a lower credit score.

VA loans

The Department of Veterans Affairs offers qualifying service members, veterans and their spouses VA loans that have a number of benefits.

VA loans require no down payment if the sale price is less than or equal to the appraised value, and there is no mortgage insurance. Plus, you can borrow up to the Fannie Mae and Freddie Mac conforming loan limits (plus more if you have a down payment).

Borrowers get lower interest rates and better terms on VA loans than they do on loans from banks and mortgage companies. There are also fewer closing costs and no prepayment penalties. In order to qualify, you must obtain a VA Certificate of Eligibility.

USDA loans

The U.S. Department of Agriculture offers no-down-payment mortgage loans that help buyers with low to moderate incomes afford safe, sanitary homes in qualified rural areas.

There are several types of USDA loans, but they all tend to come with the same requirements:

• Steady income and employment
• Debt-to-income ratio of 41% or less
• Home must be located in a qualified rural area

There are no set credit requirements, since USDA loans are offered through private lenders. There is also no maximum purchase and no maximum acreage limit on the property.

Government-backed refinancing loans

Each of the agencies discussed above — the FHA, the VA and the USDA — offers rate and cash-out refinancing loans alongside their mortgage products.

For FHA refinancing, you generally need 20% equity in your home, a 580 FICO credit score and documentation proving 12 months of timely mortgage payments.

If you have a home loan through the VA, you can refinance that loan using either a rate or cash-out refinancing loan. Non-VA loans don’t qualify. Other loan terms vary by lender.

The USDA offers a streamlined refinancing program that allows borrowers with little to no equity to refinance USDA loans to get a better rate.

FHA 203(k) loans

The FHA 203(k) program provides special purchase and refinancing loans for homes in need of repair. These loans let buyers bundle the purchase price and eligible repair costs (as long as they’re at least $5,000) into one loan.

Borrowers can obtain these loans through any FHA-approved lender. You’ll need at least a 500 credit score, although certain lenders may have higher requirements. Down payment requirements are the same as regular FHA loans. Also, you can’t have any foreclosures in the past three years.

Energy-efficient loans

Energy-efficient loans are available to homebuyers purchasing qualifying homes. At the federal level, you can obtain these through the FHA’s Energy Efficient Mortgage program. Any homebuyer of an energy-efficient property who meets the FHA’s income guidelines may qualify. Many states offer their own programs as well.

Native American Direct Loans

Native American Direct Loans are a unique type of VA loan dedicated to helping Native veterans and their spouses afford homes.

Many of the requirements and much of the process for getting NADLs are the same as with standard VA loans. However, your tribal government must have an agreement or a Memorandum of Understanding with the VA explaining how the program will work on the tribal government’s lands.

Pros and cons of government home loans

Government home loans offer a number of benefits, but they’re not for everyone. Here are some pros and cons of government-backed loans for home purchasing.

Pros of government-backed home loans

• Easier qualification: Most government-backed home loans have lower income and credit requirements, making it easier for applicants to qualify.
• Lower down payment: Most government-backed loans require a much lower down payment than conventional loans. Some loans, such as VA loans, require no down payment at all.
• Better rates: Lenders are more flexible with interest rates because the federal government guarantees the loan in case of default.
• Usually lower mortgage insurance requirements: Some government home loans don’t require mortgage insurance despite the lower down payment.

Cons of government-backed home loans

• Special requirements: VA loans, NADL loans and USDA loans all have special requirements for qualifying, including for both the borrower and the property.
• Occupancy: FHA and VA loans in particular require the owner to occupy the home for at least one full year. You must also move into the home within 60 days of closing on the loan.
• Mortgage insurance costs on FHA loans: FHA loans require you to pay mortgage insurance, which protects lenders from losses.
• Loan limits: Government loans tend to limit the amount you can borrow, as they aren’t meant for excessively expensive homes relative to an area’s cost of living.

Aside from special status (such as being a veteran), your income and credit score will play a big role in determining whether a conventional or government-backed loan is right for you. For example, newer homebuyers may have short credit histories, lower incomes or more debt. Government loans make homeownership more accessible to them. On the other hand, buyers with high income and strong credit are more likely to choose conventional mortgages.

Alternatives to government home loans

If a government home loan isn’t part of your homebuying plan, there are plenty of alternatives for buying and renting. Here are some of your options:

• HUD Housing Choice Vouchers Program: The Department of Housing and Urban Development provides tenants with a subsidy they can use at privately owned rentals that meet program requirements. You can apply through your local public housing agency.
• HUD Section 8 Project-Based Rental Assistance: The government pays rental assistance to owners of multifamily rental housing for low-income families.
• Public housing: Local housing agencies manage rental housing for low-income families, seniors and people with disabilities.

These are just a few options. States often have their own affordable housing programs as well. To find out if you qualify for affordable housing assistance programs, check out state-specific information from HUD.

Bottom line

Buying a home is likely the largest financial transaction you’ll ever make. Qualifying for a traditional mortgage can be tough if you’re new to homebuying or your income or credit is lower than average. Fortunately, buyers have options beyond conventional mortgages, including government-backed loans, with benefits such as low or no down payments, lower closing costs and no mortgage insurance. Compare conventional loan offers and FHA, VA and USDA loans before making the right choice for your situation.