Government Backed Mortgages

In 1934 the Federal Housing Administration (FHA), established a mortgage program designed to help lower income borrowers obtain a mortgage. At the time, homes were much less expensive and the acceptable practice was for a buyer to put down fifty percent of the home's value as a down payment. Despite the lower cost of homes, this obviously presented a serious problem to many people who had sufficient income to pay a mortgage, but could not, for whatever reason, come up with a large down payment.

FHA loans are government backed, which means that they are offering a type of insurance to the lender against default. This protection enables banks to take the risk of offering a loan to someone they would otherwise find unqualified. The FHA does not actually make loans to anyone or decide what interest rates will be on a loan, instead they serve as a guarantor against default for the bank.

FHA loans can be used to purchase a home, refinance one, pay for 1-4 unit properties like condominiums and manufactured homes that are 'ground-set' or have a permanent foundation. Because these loans are insured by the government, they have much simpler credit requirements than non FHA loans and also bring with them the benefit of not needing a large down payment (as small as 3%), and smaller closing costs that can also be bundled with the loan amount, saving substantial up-front money for the borrower.

VA Loans

The VA loan is nearly identical to the FHA loan in how it is a government-backed mortgage, giving banks substantially more leeway in deciding who may qualify for one. Unlike FHA loans, however, VA loans are restricted to use only by active duty service members of the U.S. armed forces, retirees or those who separated before retirement and did not do so dishonorably. VA loans are offered as another substantial perk to serving in the military and most mortgage lenders across the country will willingly work with a VA loan guarantee. You may, however experience some difficulty finding a seller who is interested in working with a buyer using a VA loan because often the closing costs for a VA loan are stipulated to be paid by the seller of the home rather than the buyer.

Private Mortgage Insurance

One significant downside to both types of government backed mortgage is the private mortgage insurance requirement, or PMI. PMI is a type of insurance that is added to the mortgage payment you make each month for as long as you have less than an 80% loan to value interest in the mortgage. This means that if you put less than 20% down on your mortgage, you will immediately be liable to start paying private mortgage insurance. It is not very expensive, but will remain a part of the loan until either the home's value increases to where you owe less than 80% of the home's value or you make payments sufficient enough to lower it. In most cases you will have to request that the lender remove PMI if you believe you are eligible to stop paying it.