In today’s mortgage marketplace there are two basic types of home loans: conventional and government-backed. Conventional loans are those typically underwritten to Fannie Mae and Freddie Mac guidelines while government-backed mortgages carry some level of guarantee to the lender that approved the application. As long as the lender followed proper protocol when underwriting a government-backed mortgage application, the guarantee applies.
These guaranteed loans are those underwritten to VA, FHA and USDA guidelines. Let’s look at these three programs.
VA loans are available to a select group of borrowers. Those borrowers are veterans, active duty personnel with at least 181 days of service, National Guard and Armed Forces Reserve members with at least six years of service and un-remarried surviving spouses of those who have died while serving, or as a result of a service-related injury. The VA loan program is a zero-down product, one of the few zero-down home loans on the market. As it relates to the lender’s guarantee, should the loan go into default – which is rare because the VA loan is one of the highest performing in the industry – the lender is compensated at 25 percent of the loss. This guarantee is financed by what is known as the Funding Fee and for first time VA buyers taking out a 30 year loan and no money down, the fee is 2.15 percent of the sales price which is then rolled into the final loan amount.
FHA loans have no such restrictions as to eligibility. FHA loans are under the auspices of the Department of Housing and Urban Development, or HUD, and also carry a guarantee to the lender. Should an FHA loan go into default, the lender is compensated for the loss. This compensation is financed with two separate forms of mortgage insurance: an upfront mortgage insurance premium and an annual premium paid in monthly installments. These two fees have varied over the years but today the upfront premium for FHA loans is 1.75 percent of the loan amount when the minimum down payment of 3.5 percent is made and 0.85 percent of the loan amount for the annual premium. The upfront premium is also rolled into the final loan amount.
The USDA loan is the last of the three government-backed programs and is designed to finance properties located in rural and semi-rural areas. The USDA program is also a zero-down loan and offers a 30 year fixed rate program. There are income limitations with the program and is also dependent upon the number of people living in the household. This program is considered a moderate income program limiting household income to 115 percent of the median income for the area. Properties must also be located in a previously approved geographical area.
Lastly, all three of these programs are designed to finance a primary residence and cannot be used to finance a second home or rental property.