Mortgage Financing Part 2: Government-backed loans
Welcome to the final part of our series on mortgage financing. Join me as we separate myth from fact and explore whats available through government-backed loan programs
If you haven’t already read Part 1: Conventional Loans, or part 1.5: Why you should care, be sure to check those out as well.
The focus of this article will be on the government-backed (orange) side of the flowchart
Clearing up some misconceptions.
When my wife and I bought our first home, I distinctly remember avoiding government-backed loans. I thought I made too much or that they took too long to close or some other excuse. I thought I was just supposed to get a conventional loan. The truth is, about 25% of new home purchases use government-backed loans and there are a few distinct advantages government-backed loans can offer. Here are several misconceptions I often here from clients when it comes to using a government-backed loan to finance your home.
Myth #1: I make too much to qualify for an FHA or government loan.
Truth: There are no income minimums or maximums for utilizing a government-backed loan. You will have to demonstrate some ability to make loan payments on time through employment verification or some other form of income statement.
Myth #2: Government loans are too limited for the house I want to buy.
Truth: For VA loans, the limit is actually exactly the same as conventional loans. The maximum ranges by county from $424,000 to $636,000. The FHA limit is slightly lower but is still comes in at $275,000 for someone like me in Cleveland, Ohio and $636,000 for someone like my brother who lives out in San Francisco. The limits on both are even higher depending on the number of units. Not to mention, USDA loans have no maximum limit!
Myth #3: USDA loans are just for farmers.
Truth: USDA loans are available for many individuals in rural areas or small towns that qualify. Visit the USDA website for specific details for your area.
Myth #4: I have to be active duty to qualify for a VA loan.
Truth: Active duty, retired, and spouses of veterans can all qualify for a VA loan, provided the home will be your primary residence.
Myth #5: Government-backed loans take too long to close.
Truth: Ellie Mae reported recently that the average time to close for a conventional loan was 42 days. FHA-loans took on average 43 days. VA loans were actually the shortest at 41 days on average. These change from quarter to quarter but the point is: each type of loan takes about the same amount of time.
The Specifics
FHA Loans
Prior to the creation of the Federal Housing Administration (FHA) in 1934, home loans required a down payment of 50% or greater and had to be paid back in three to five years! The FHA was the first to offer long-term loans and continues to exist today to allow more people to achieve their dream of homeownership.
The FHA itself does not provide the loans, these are still obtained through a normal lending institution like a bank. The difference is that FHA loans are insured by the federal government. The FHA’s Mutual Mortgage Insurance Plan (MMIP) provides a function similar to private mortgage insurance (PMI) on conventional loans, it protects the lender in the event of borrower default. The difference is that a mortgage insurance premium (MIP) is required on all FHA loans, regardless of down payment size. For most programs the initial MIP is 1.75% of the loan amount with a 1.35% annual premium divided up into 12 monthly payments. Furthermore, the annual MIP never goes away, it will follow the loan until it is paid off. Often, this means borrowers will have higher monthly payments when compared to conventional loans.
The main advantages to an FHA loan lie within the low down payment required and the flexibility of some of it’s programs. Unlike conventional loans, which need 10% or 20% down, FHA loans only require 3.5%. This can be a huge advantage for individuals with decent monthly income but a lack of savings. Conventional loans also have much stricter requirements for credit history and annual income. As we discussed previously, conventional loans use the 28/36 rule when determining income requirements. FHA underwriting allows for limits up to 31% of your gross income and 43% of your total debt load.
There are even a few specialty loans available through FHA programs. One of the most popular is a ‘203k loan’. This offers buyers 110% of the after-repair-value of a home to allow for rehab or repair. With this product, homebuyers can quickly tap into the extra cash they need for remodeling before ever moving in. The other interesting option is called the Good Neighbor Next Door Program and is designed for firefighters, EMTs, K-12 teachers, and law enforcement officers looking at HUD properties. Through this program, buyers only pay 50% of the list price of the home! The catch is that these homes are in revitalization areas and must be occupied by the buyer for a minimum of 3 years.
VA Loans
The Veterans Administration home loan program is strictly for veterans, active duty military personnel, certain members of the reserve and National Guard, and military spouses. Through this program, a qualifying individual can purchase a primary residence with no money down toward the sale price. The purchaser must occupy the home full time and can only have one VA loan active at at a time. However, the veteran does not need to be a first-time homebuyer and the benefit can be reused as long as the individual still qualifies. Much like conventional loans, there are maximum loan limits based on county and these vary from $424,000 to $636,000.
USDA Loans
The other government-backed loan with no down payment required is offered by USDA rural development housing program. The purpose of this program is to provide low-interest, no down payment loans to families living in rural communities. There are no maximum limits for USDA loans but the home must be in an area that qualifies. These loans are also geared toward lower-income families so certain individuals may not qualify if they make too much for their particular area. For more details on particular locations visit: https://eligibility.sc.egov.usda.gov/eligibility/
Government-backed loans can offer more flexibility compared with conventional loan products. Regardless of which loan type use to finance your home, knowing your options can ensure you get a great home at a price and payment structure you can afford.