How Government-Backed Mortgages Work

By Jacqueline DeMarco · August 11, 2023 · 7 minute read

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How Government-Backed Mortgages Work

Government-backed mortgages can be easier for potential homebuyers to qualify for as these loans are insured by the federal government, which brings down the risk for lenders. There are three main types of government-backed mortgages that can help consumers — and especially first-time homebuyers — reach their goal of homeownership.

Let’s take a closer look at these different types of government-backed mortgages and how these government-backed insured mortgages work.

What Is a Government-Backed Mortgage?

Essentially, a government-backed mortgage is a mortgage loan that a federal government agency insures. These types of mortgages are typically easier to qualify for than conventional home loans, as the lender takes on less risk due to the government insurance that forms the safety net underpinning the loan.

Of course, consumers can also apply for non-government-backed mortgages, so it’s important to do your research before applying for home loans to see which mortgages best suit your financial needs.


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How Do Government-Backed Mortgages Work?

Let’s take a closer look at how government-backed home loans work. To start, they are insured by one of three different federal agencies.

•   Federal Housing Administration (FHA loans)

•   U.S. Department of Agriculture (USDA loans)

•   U.S. Department of Veterans Affairs (VA loans)

The way this works is that if the borrower defaults on the loan, the government repays the lender instead. This greatly reduces the risk that the lender faces, which means they can in turn extend more favorable interest rates to borrowers who may not normally qualify for low interest rates. Many government-backed loans also don’t require a down payment.

Most of these loans are not issued by the government. Consumers still have to apply with private lenders and it’s a bit hit or miss which (if any) types of government-backed loans a private lender might offer.

A government-backed loan works differently than a conventional loan. To start, conventional loans don’t have any government backing and therefore have stricter eligibility requirements. Typically, government-backed loans also have different mortgage insurance requirements than conventional loans and may charge more upfront fees.

Borrowers who choose a government-backed loan also have to meet different eligibility requirements than borrowers who choose a conventional loan. For example, only members of the military or select family members can qualify for a VA loan.

Different Types of Government-Backed Mortgages

There are three different types of government-backed mortgages: FHA, VA, and USDA loans. Each type of mortgage is designed to meet the unique needs of different borrowers. Some consumers may qualify for all three loan types or they may meet the requirements and qualify for just one type of mortgage-backed loan. In some cases, a borrower may not qualify for any of these loans.

•   FHA loans This loan type is backed by the Federal Housing Administration and it tends to be much easier to qualify for than USDA and VA loans. FHA loans are popular with first-time homebuyers. Having a credit score of at least 580 is a must and a down payment of 3.5% is necessary. Those with a credit score in the 500 to 579 range can still qualify, but only if they make at least a 10% down payment. The main disadvantage of FHA loans is they require mortgage insurance initially. If the borrower makes a downpayment of 10% or more, after 11 years the lender can remove the mortgage insurance requirement, but many borrowers need to refinance to escape this insurance.

•   USDA loans Low- or moderate-income borrowers looking to buy a home in a rural area or select suburban areas may qualify for the USDA’s Rural Development Guaranteed Housing Loan Program. There are a few different types of USDA loans and which one a borrower can qualify for depends on their credit score and income. There are no down payment requirements with USDA loans, but there are mortgage insurance requirements. There is no way to remove mortgage insurance from the loan, however the insurance payments are typically lower than those for conventional or FHA loans.

•   VA loans VA loans are only available to active-duty service members, veterans, reservists, National Guard members, and certain surviving spouses. There are no credit score requirements for VA loans or down payment requirements, although some lenders may have their own credit score requirements. There are no mortgage insurance requirements for VA loans, but there are some extra closing costs that can equate to 1.4% to 3.6% of the loan amount.

Pros and Cons of Government-Backed Mortgages

There are some unique advantages and disadvantages associated with government-backed mortgages:

Pros

•   Can be easier to qualify for than conventional loans

•   Lower down payment requirements (or no down payment at all)

•   Lower credit score requirement (or no requirement at all)

•   Potentially lower interest rates

Cons

•   VA and USDA loans can be hard to qualify for

•   You may need to pay mortgage insurance for the life of the loan

•   Not all lenders offer government-backed mortgages

Examples of Government-Backed Mortgages

There are three types of government-backed mortgage. They are USDA loans, VA loans, and FHA loans. Here is how a USDA loan might work: Let’s say you are home-shopping in an area with a population under 20,000. If you have an average or only slightly above-average salary for the area and a credit score of 640 or higher, you might qualify for a USDA loan. (So, for example, if the median annual income in the area is $62,000, you could qualify with a salary of $71,300 or less.) If you borrowed $100,000, you would have a $1,000 mortgage insurance cost upfront, and you would pay about $29 per month for mortgage insurance after that.

If your military service history makes you eligible for a VA loan, you would likely need a credit score of at least 580 to go with a VA loan. You wouldn’t need a down payment or mortgage insurance, but you would pay an upfront funding fee of between 0.5% and 3.6% of the loan amount unless exempt. Your purchase would need to be a primary home, but unlike with the VA loan, there are no restrictions on where that home could be located or what your annual income might be.


💡 Quick Tip: Your parents or grandparents probably got mortgages for 30 years. But these days, you can get them for 20, 15, or 10 years — and pay less interest over the life of the loan.

Is a Government-Backed Mortgage Worth It?

Whether or not a government-backed mortgage is worth it depends entirely on the borrower’s other home loan options. It’s generally a good idea to shop around with different lenders for the best possible deal. Spend some time comparing potential interest rates, fees, and mortgage insurance requirements to see which loan will cost the most in the long run. First-time homebuyers often find government-backed mortgages especially attractive, in part because it can be difficult to come up with a down payment for a first home.

The Takeaway

Government-backed mortgages can be a great option for borrowers, especially those who don’t qualify for a conventional mortgage. While these government-backed mortgage loans can be hard to qualify for if the borrower doesn’t meet unique requirements (like being a military member or buying a home in a rural area), they can have more relaxed credit score and down payment requirements than those of conventional mortgages.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.


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FAQ

What are government-backed mortgages?

Government-backed mortgages are mortgage loans insured by a select federal government agency. There are USDA, FHA, and VA loans available to eligible borrowers. Because these loans are insured by the federal government, the private lenders who issue them take on much less risk and can work with borrowers who wouldn’t traditionally qualify for a home loan.

What are the benefits of a government-backed mortgage?

Often, government-backed mortgages are much easier to qualify for than conventional mortgages. They typically have lower credit scores and downpayment requirements. Because these loans are insured by the federal government, lenders can work with “riskier” borrowers to whom they may not normally offer a conventional home loan.

What are the three types of government-backed loans?

The three main types of government-backed loans are FHA, VA, and USDA loans. The Federal Housing Administration offers FHA loans, the U.S. Department of Agriculture backs USDA loans, and the Department of Veterans Affairs is responsible for VA loans.


Photo credit: iStock/Prostock-Studio

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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