What is a Government-Backed Home Loan?

Written by Posted On Thursday, 30 June 2022 00:00

There are conventional loans and there are government-backed loans. Conventional loans are those where the lender assumes the risk of issuing a mortgage. Most such loans fall into the Fannie Mae and Freddie Mac category. Should an approved mortgage ever go into default, the lender suffers the loss. Fannie and Freddie both buy mortgages on the secondary market for the primary reason to keep liquidity in the home loan industry. 

A government backed home loan is one where there is an insurance policy associated with the loan and covers the lender's loss should the home go into default. As long as the loan was approved using issued guidelines, the guarantee will apply.

VA loans fall into this category. Home loans approved using standards set by the Department of Veteran's Affairs provide a guarantee to the lender of 25% of the loan balance. Eligible borrowers for a VA loan include veterans, active duty personnel with a minimum of 180 days of service, National Guard and Armed Forces Reserve members with at least six years of service and certain surviving spouses of those who have died while serving. The insurance policy is financed with a Funding Fee which is rolled into the loan amount.

Another government backed home loan is the USDA mortgage. The United States Department of Agriculture has a program that provides financing for properties in rural and semi-rural areas. There is no down payment required for a USDA mortgage, just like there is no down payment requirement for a VA loan. Most mortgage loans require there be similar properties in the area with the one being financed. Because there are few, if any, homes listed in various rural areas thoughout the country, conventional financing isn't available. USDA loans take this into consideration and do in fact finance homes in such areas. Homes must be located in one of these designated areas and the USDA keeps a list of zip codes that are approved for a zero-down USDA loan. Should the loan go into default, the lender is compensated for the entire loss. The guarantee is also financed by insurance policies paid for by the borrower.

Finally, the most popular government-backed mortgage is the one written to standards issued by the Federal Housing Administration. The FHA loan does not have any individual classification requirements not do loans have to be in any designated area like USDA loans do. While there is a down payment needed for an FHA loan, it is just 3.5% of the sales price. The FHA guarantee is financed with both an upfront policy and one paid through monthly installments to the lender. Should an FHA loan go into defaul, the remaining balance is fully refunded to the lender. Lenders like to issue FHA loans due to this type of protection. FHA loans also have relaxed approval guidelines when compared to other conventional low down payment programs.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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