Federal government agencies issue government-backed loans. The government isn’t actually loaning you money to buy a home; it sponsors the programs available. It’s still up to you to find a mortgage lender to access these programs.
Besides government loans, there are private conventional loans. But which are easier to qualify for? According to the Federal Reserve Bank of New York, more than 20 percent of mortgage applicants have been rejected. Knowing which type of loan to apply for could keep you from being one of the 20 percent.
How Conventional Loans Work
Conventional loans are held by groups such as banks, credit unions, and savings and loan associations. Homebuyers can qualify for a loan from any of these institutions or work with a mortgage broker that writes the loan and then sells it to another institution.
According to Capital Bank, traditionally, a conventional mortgage required a 20 percent down payment based on the home’s price. The rest would be borrowed on a 30-year mortgage.
But the good news is that conventional loans are now more flexible. There are now varied terms and a lower down payment requirement. For example, you can sometimes qualify for a mortgage with a 10 percent down payment or less.
However, Capital Bank points out that 20 percent gives you “a lot more skin in the game” and provides you with a sizable amount of equity. This assures the lender that you will be less likely to default on mortgage payments.
Borrowers who pay less than 20 percent may need to purchase private mortgage insurance (PMI) to protect the lender’s investment.
Conventional mortgages aren’t backed by the government. The result is that they have stricter eligibility requirements than federal loans.
Four Types of Federal Loans
There are four types of federal loans:
- Federal Housing Administration (FHA) loans
- U.S. Department of Veterans Affairs (VA) loans
- U.S. Department of Agriculture (USDA) loans
- Native American Direct Loans (NADL)
Some have unique qualification requirements, but all of them have lower down payment requirements than conventional loans.
As part of the Department of Housing and Urban Development (HUD), FHA loans are the most common government loans and are popular among first-time homebuyers with minimal savings and low credit scores. They require down payments for as low as 3.5 percent, according to Zillow.
Veterans Affairs loans are available with no down payment, but they have limited eligibility requirements. You must be one of the following:
- active-duty military service member
- veteran
- National Guard and Reserve members
- eligible surviving spouse
Eligible homebuyers can use the program multiple times throughout their lifetime.
The USDA loan is backed by the U.S. Department of Agriculture and backs home purchases in eligible rural areas. These loans don’t require a down payment.
The NADL is geared toward Native American veterans and their spouses. Eligible individuals are not required to make a down payment.
Requirements for Federal Loans
Different programs have specific credit score requirements. The most liberal credit score requirements are with the federal loans. For example, FHA loans are geared toward first-time homebuyers with little savings. They also require a lower credit score than a conventional loan.
FHA Loans
An FHA required credit score is at least 500, although you may need a higher down payment to qualify. But they require an upfront mortgage insurance premium, typically 1.75 percent of the loan, according to Mortgage Equity Partners. They also require annual mortgage insurance (MIP) that’s added to your monthly payment.
Their debt-to-income ratio (DTI) is 43 percent according to Business Insider. Debt-to-income ratio means your total debt, including car loans, credit cards, and student loans. It is then compared to your income.
And unlike conventional loans, where the PMI automatically drops off once you reach 20 percent of equity, the MIP isn’t eliminated unless you refinance into a conventional loan.
With an FHA, you must buy a home that falls within specified loan limits and live in the home as your primary residence.
VA Loans
The VA loans have flexible credit scores that typically start at 660, according to Business Insider. However, each lender sets its own standards. They don’t require PMI and have competitive interest rates. The VA loans’ DTI is 41 percent. They usually charge lower interest rates than conventional loans. But you must live in the home as your primary residence. And there is a limit to how much you can borrow.
USDA Loans
USDA loans don’t have a set minimum credit score, but many lenders require a minimum credit score of 640. They require 41 percent DTI. You are also limited to living in the home as your primary residence, and it must be in a rural area, although there are some exceptions.
Requirements for Conventional Loans
Conventional loans have stricter guidelines and qualifiers. They require a credit score of at least 620, but a 740 score will provide the best loan terms.
Their DTI is 36 percent, which is lower than that of federal mortgage programs. They also require proof of cash available for any down payments.
Although not backed by the government, they do follow the guidelines of mortgage lenders Fannie Mae and Freddie Mac.
Conventional Loans Are the Most Popular
On the surface, a federally backed loan may seem like the best option, but according to AmeriSave, in 2023 73 percent of single-family home purchases were made with conventional mortgages.
Unlike VA and USDA loans, which have property restrictions, conventional loans can be used to purchase any type of property once you qualify. This includes primary residences, second homes and investment properties. Conventional loans are also offered by most lenders.
There are also faster closing times with a conventional loan because you don’t need government approval like FHA, VA, and USDA loans do.
Borrowers can avoid government-related fees, such as the MIP. Lenders for conventional loans have more flexibility in setting charges, with some eliminating origination fees.
Overall, applying for a conventional loan can sometimes be an easier process.
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