Step-by-Step Series #1: Financing Your New Home Purchase-Is a Government Backed Loan Right for You?
Mortgage loans backed by the U.S. government offer homebuyers an attractive alternative to conventional loans. How can you determine if a government loan is right for you?
“There are several neat things about government loans,” says John West, Director of Retail Loans at Direct Lenders LLC in Kennesaw, Ga. “They have very competitive interest rates and low down payment options. A borrower can qualify with a lower credit score and higher debt ratio than any other loans offered. Government loans also have the most forgiving guidelines for previous bankruptcies and foreclosure history.”
The two most common types of government-backed loans are FHA (Federal Housing Administration) loans and VA (Veterans Administration) loans. VA loans are restricted to eligible veterans, active duty military personnel, and surviving spouses, while FHA loans are open to all borrowers. Both products may limit the amount of a loan, but they are generally friendlier to borrowers with credit issues or little money to put toward a down payment.
Does that mean that borrowers should automatically choose a government loan? Not necessarily, says Ryan Hamil, Branch Sales Manager at MB Financial Bank in Carrollton, Ga.
“There is not a ‘one-size-fits-all’ answer to the question of which type loan is best,” Hamil says. “For borrowers with a 680+ credit score and at least 5 percent to put toward a down payment, conventional is almost always the best choice. However, in some cases, even with the previously mentioned specifics, FHA still may be the best or only route.”
One key determining factor may be the borrower’s debt-to-income ratio, or the percentage of gross monthly income that goes toward paying monthly expenses like housing, alimony, child support, car payments, and other installment or revolving credit accounts, Hamil said.
“If a borrower’s debt-to-income ratio is above what conventional will generally approve (roughly 45 percent), FHA becomes the only option, since FHA can allow up to a 57 percent debt-to-income ratio.”
Down payment is another factor.
“If you’ve got 15-20 percent saved for a substantial down payment, a conventional loan is better,” West said. “If you have a modest amount saved, an FHA loan is the best way to go.”
“FHA requires a minimum of 3.5 percent down, and conventional will allow as little as 3 percent down, depending on credit scores,” Hamil said.
The process of purchasing your first home is an exciting time, but it can be overwhelming and confusing if you are unprepared, Hamil says.