Second Choice: Conventional or Government Loan

A conventional mortgage is one that is not insured by the government in any way. This home loan is made in the private sector with no form of government backing.

A government-backed loan is insured by some type of federal agency, such as the Department of Veteran Affairs (VA) of the Department of Housing and Urban Development (HUD). The loan may still be made in the private sector, but the lender receives insurance from the federal government.

There are several types of government mortgages:

  • FHA loan — This mortgage is made by lenders in the private sector (known as FHA-approved lenders) and is insured through the Federal Housing Administration. If the borrower defaults on the loan, the lender gets paid by the FHA.
  • VA loan — This program is reserved for military service members and their families. It can be used to finance 100 percent of a home purchase, which eliminates the need for a down payment. This program is managed by the Department of Veteran Affairs. If you’re a military member, you should have a VA specialist somewhere within your command. They can provide you with details about the program.
  • USDA loans — These used to be called RHA loans, for the Rural Housing Administration. The program is overseen by the United States Department of Agriculture, or USDA. This type of mortgage loan is reserved for people who live in certain parts of the country. There are income restrictions as well. They are sometimes referred to as “farmer loans,” due to the geographical and demographic nature of the program. But you certainly don’t have to be a farmer to qualify. The program is designed for low-income residents of rural areas.

The Rise of the FHA Loan

The FHA home loan is by far the most popular and widely used of the government programs. As of June 2011, FHA loans accounted for about 30 percent of the overall mortgage market. Their market share was in the single-digit percentages just a few years ago.

Why are they so much more popular today? Because the private mortgage market has gotten stricter with its lending requirements since the housing crash. So a lot of home buyers with less-than-perfect credit have no choice but to use the FHA program (with its more flexible lending guidelines).

This is the government-backed loan I want to focus on the most. The other two programs (VA and USDA) are something of a no-brainer. Those programs are probably your best option, if you qualify for them. But there’s more to consider when choosing between a conventional or FHA loan. So let’s talk about those considerations.

The biggest benefit for this type of mortgage is the down payment. With an FHA home loan, your down payment could be as low as 3.5 percent of the purchase price. A conventional home loan, on the other hand, will require a minimum down payment of 5 – 10 percent. The FHA program is also more lenient than the conventional mortgages. So if you have a below-average credit score or other qualification problems, it might be your best option. It might even be your only option.

There are also certain drawbacks to the FHA program. You’ll have to pay a premium for government mortgage insurance. This helps the Federal Housing Administration cover its own losses resulting from lender insurance claims. Actually, you have to pay two different premiums — upfront and annual.