What is an FHA Loan? What is a VA Loan? How are They Different from a Typical Mortgage Loan?
For those with poor credit and a lack of substantial savings, homeownership may seem like an impossible goal. Part of this problem may be due to not being able to secure a mortgage with favorable terms or providing a large down payment. Are there are ways to avoid these problems and still pursue the dream of owning a home?
The answer is yes, by applying for FHA loans and VA loans. In this article, we will cover the basics of these loans and how they differ from a typical mortgage loan.
What are Government-Backed Loans?
The federal government offers a number of paths to homeownership that enable individuals that may not be able to qualify for private loans. The two most common government-backed loans include the VA loan and the FHA loan.
Let’s take a deeper look at each mortgage type and how they different from typical mortgages from private lenders.
VA mortgages are government-insured mortgages (through the U.S. Department of Veterans Affairs) that are designed to help active or veteran military service members and their spouses attain homeownership.
VA loans feature no required down payment, which helps prospective homeowners attain homeownership without a substantial initial investment. VA loans also feature low interest rates and now private mortgage insurance (PMI), making it a good long-term option.
However, VA loans do have a few requirements:
- First, in order to qualify for a loan through the VA, a satisfactory credit score of 620 and above is necessary. For those with a spotty credit history or none at all, this can be a significant challenge.
- Second, the borrower must have a Certificate of Eligibility (COE). The COE provides proof that the applicant meets the minimum military service requirements to qualify for the loan. Individuals qualify for a COE depending on the length of service and relationship of the applicant to the service member. For example, National Guard members have to provide a minimum of 6 years of honorable service, are mobilized for active duty service for a period of at least 90 days, or are discharged because of a service-connected disability.
- Last, VA loans are only available for those that intend to use the home as a primary residence.
To learn more about VA loans, specific guidelines and eligibility requirements can be found on the U.S. Department of Veterans Affairs’ website.
Insured by the Federal Housing Administration, FHA loans are available to low- to middle-income individuals that are seeking to purchase a home. FHA loans are an attractive option for many individuals, as FHA loans only require 3.5% down payment for a home (instead of 10 - 20% required by many lenders). For example, a home that is valued at $200,000 only requires $7,000 upfront to secure an FHA loan.
In comparison to VA loans, FHA loans are available to most U.S. citizens, most commonly first-time homebuyers. FHA loans, however, have more stringent requirements and require more upfront money:
- Borrowers must have a satisfactory credit score (580 and above) to qualify for a low 3.5% down payment.
- Lower credit scores, such as 500 - 579, require a higher down payment of 10% to qualify for a loan.
- Down payments can be gifted by a family member.
- FHA mortgages require borrowers to pay mortgage insurance premiums (MIP). MIP is designed to insure the loan in the event that the borrower defaults on their mortgage payments.
- The home must be a primary residence
- FHA loans require a professional property appraisal from an FHA-approved appraiser.
- Borrowers must have two years of steady employment history with the same employer
- Borrowers must be 2 years out of bankruptcy.
- Borrowers must be 3 years out of foreclosure.
- A borrower’s mortgage payments must be 31% of gross income. This percentage includes HOA fees, mortgage insurance, property taxes, and homeowners insurance (referred to as the front-end ratio). Exceptions are allowed for up to 40% of gross income, but lenders will typically have to provide documentation to qualify the risk of the loan.
- A borrower’s debt must be less than 43% of their gross income. This includes the mortgage as well as monthly debt, such as car payment, student loans, credit card payments and more (referred to as the back-end ratio). Exceptions are allowed up to 50%, but lenders will typically have to provide documentation to qualify the risk of the loan.
For more information about FHA loans and whether prospective homeowners qualify, visit the FHA’s website to learn more.