Government-backed home loan terms tend to be better for borrowers than conventional mortgages because the government assumes some of the lenders’ risk.
If a borrower of an FHA mortgage stops making payments and the loan goes into default, the government reimburses the lender. If a borrower of a conventional home loan stops making payments, the lender takes the hit because the government is not involved.
The foreclosure process is expensive and takes ample time, which lenders do not always have. Not to mention, lenders do not always recover their losses from foreclosure sales.
It is often easier to secure government loans than traditional loans, especially if any of the following apply:
- You do not have 20% of the purchase price for a down payment
- Your credit is less than perfect
- You have a prior foreclosure
- You have declared bankruptcy
- You need help paying closing costs
While FHA and USDA home loans (loans from the U.S. Department of Agriculture) have fewer barriers, borrowers still need to meet lenders’ qualification requirements. Most lenders decline applicants who do not have a source of income or have very poor credit.
Government loans for home purchases do not have a credit score minimum. However, most lenders do.
In most cases, you can meet the requirements with a minimum credit score of 640. The better your credit score and history, the more likely you will qualify for low-interest rates.
Lenders also prefer borrowers with a debt-to-income (DTI) ratio of 42% or less. The amount of money you spend each month must be less than half of your income.
The most common sources of debt include credit cards, student and car loans, property taxes, homeowners’ insurance, and more.
Along with credit score, prospective borrowers must meet other requirements determined by lenders.
For example, a non-traditional income can complicate home loan underwriting. Freelancers and self-employed people may have to show a longer history of earnings or pay a higher down payment.
There are a few things you can do to improve your chances of qualifying for a home loan. These include the following:
- Pay off outstanding debt
- Reduce monthly expenses
- Increase your monthly income
- Fix errors on credit history
- Maintain steady employment
- Save more money for the down payment
Some government-backed home loans are only for lower-income buyers. Higher earners may not qualify for these loan benefits, such as USDA loans. Likewise, the government may require the property to be in a designated area, like a rural community.
FHA and USDA loans are ideal for prospective homebuyers in lower-income brackets with fair to bad credit history. Discover more about low-interest government loans, like FDA and USDA loans, in the next slide.