Have you heard the term “guaranteed loan?” It’s possible, but it’s mortgage industry parlance that describes a specific feature of a mortgage program. There are three such programs and they’re all guaranteed to some degree by the government. It’s a government-guaranteed loan and there are three of them. The three are the VA, FHA and USDA loans. But at first glance the term might be a bit misleading, perhaps implying that someone who applies for one of these loans is guaranteed to be approved but that’s not how it works. There is a guarantee but it is a guarantee to the lender, not the borrower. Let’s take a closer look.
The VA loan program has been around since the end of WW II. Introduced in 1944, the VA loan was part of a broader package that was awarded soldiers returning from battle. The VA loan guarantee is 25 percent of the lender’s loss should the loan go into foreclosure. That doesn’t happen very often with a VA loan however, as VA loans are the highest performing of any other mortgage type. But where did the 25 percent come from?
It comes from the way VA entitlements were originally calculated. The maximum VA loan for any individual is four times the outstanding entitlement amount. This amount has changed over the years but today the maximum entitlement is $36,000. Four times $36,000 is $144,000. But $144,000 won’t buy much of a home, especially in the San Jose area. Later, it was decided that the maximum VA loan amount would mimic the maximum loan amounts for Fannie Mae and Freddie Mac. For most parts of the country, the maximum is $484,350. In higher cost areas, such as ours, the maximum is $726,525.
The 25 percent qualifying calculation has essentially been abandoned but the VA loan guarantee is still 25 percent of the loss. This guarantee is financed by the Funding Fee, which is calculated as a percentage of the loan amount and rolled into the final loan. Those that are eligible for the VA loan are veterans of the armed forces, active duty personnel with a minimum of 181 days of service, National Guard and Armed Forces Reserve members with at least six years of service and unremarried surviving spouses of those who have died while serving or as a result of a service-related injury. Finally, there is no down payment required for a VA loan.
The FHA loan has no such restrictions as to eligibility. The guarantee to the lender is at 100 percent of the loss should the loan go into foreclosure. As long as the loan was approved using FHA standards the guarantee will be in place. This guarantee is financed by two separate mortgage insurance policies, not one like the VA’s Funding Fee. There is an upfront mortgage insurance premium that is rolled into the final loan amount and an annual one that is paid in monthly installments.
FHA loans are the most popular with first time buyers. This is primarily due to the low down payment required of 3.5 percent as well as somewhat relaxed approval guidelines. Lenders are allowed to approve FHA loans with a 3.5 percent down payment and scores as low as 580. Most lenders however will set their own minimum score that can range from 600 to 640.
The third and final government-guaranteed loan is the one following guidelines set by the United States Department of Agriculture, or the USDA. The USDA loan is designed to finance properties in rural areas the government has identified. It’s difficult to finance a rural home with a conventional loan due to the lack of recent sales of similar properties in the area. The USDA program focuses instead on where the property was located as well as placing limits on household income. For all occupants 18 years of age and older, adjusted income cannot exceed 115% of the median income for the area. The program is offered as a 30-year fixed rate loan. The USDA guarantees the full amount of the loss should the loan ever go into default. This loan guarantee is also financed by two separate mortgage insurance premiums, as does the FHA program. There is an upfront fee rolled into the loan amount and an annual one paid in monthly premiums.
All three government-backed programs are designed to finance an owner-occupied property and cannot be used to finance a second home, investment or rental property. These programs are very competitive and provide financing answers that conventional loans cannot sometimes address. If you’d like to finance a home with as little cash as possible, one of these loans just might be the perfect fit.