Types of Mortgages and Government-Backed Loans

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Mortgages come in all shapes and flavors, hardly a surprise when you consider that millions of home loans are originated each year. There are different mortgages for different purposes.

To be a successful mortgage borrower, it helps to know the options available today. Here’s a brief and concise list of mortgage options arranged according to borrower needs.

The big three: Conforming, FHA, and VA financing

The vast majority of residential mortgages today – about 85% – fall into three programs. 

Conforming Mortgages

So-called “conforming” mortgages represent the majority of loans originated at this time. These are mortgages that meet the standards established by Fannie Mae and Freddie Mac, thus they are “conforming.”

The great beauty of conforming loans is that they represent little risk to borrowers. Typically 30 years in length, conforming loans allow qualified borrowers to finance most available properties with comfortable monthly payments. 

Conforming loans are often associated with 20% down payments. If you can finance with 20% down, the lender has less risk and will not require mortgage insurance, a big monthly saving.

However, it’s possible to get conforming mortgages with much less upfront – say 5% – by using private mortgage insurance. Also, borrowers require just 3% down with the HomeReady (Fannie Mae) and Home Possible (Freddie Mac) programs.

FHA Mortgages

FHA loans now represent a little more than 20% of the mortgage marketplace. This is a federal program that allows borrowers to finance with 3.5% down in most cases.

It’s widely recognized as the financing of choice for first-time home buyers – in fiscal year 2023, a period that ended September 30th – 82% of all FHA purchase money mortgages went to first-time buyers. 

The FHA program is popular because of the low down-payment requirement and also because of its liberal underwriting standards. The typical FHA credit score in fiscal 2023 was 670. The higher the score, of course, the lower the interest rate.

Another reason for the popularity of the FHA program is that it accepts liberal debt-to-income (DTI) ratios. The DTI ratio compares gross monthly income with recurring debt payments for such things as housing, auto loans, student debt, and credit card bills. 

In fiscal 2023 the FHA average DTI was 45.1%. More than 30% of the loans backed by the FHA programs had a DTI above 50%, and it may be possible to get an FHA-backed mortgage with a 57% DTI average. 

However, borrowers need to ask if their monthly income is sufficiently stable to support a higher debt load. After all, income may fall or a job can be lost. Many lenders limit DTIs to lower percentages to ensure borrowers can repay their loans. 

VA Mortgages

Loans supported by the VA mortgage program are available to those with qualifying federal service in the US military. It has a combination of benefits that are unique in the mortgage marketplace, including both nothing down and no monthly charges for mortgage insurance. 

VA qualification standards have evolved over time. Individuals in the active military at this time as well as members of the National Guard and Reserves need 90 days of active service to qualify, including 30 consecutive days. 

The VA does not require a minimum credit score to qualify for financing and does not have a loan limit. Instead, it leaves qualification standards to individual lenders, and they may have their own credit score and loan size standards. 

However, the VA has both debt-to-income and residual cash standards that must be met.

The preferred debt-to-income ratio is 41%, but higher ratios are possible for borrowers with tax-free income or a strong residual income. 

The residual income standard is used to make certain that borrowers have cash for everyday expenses. The way it works is that the VA estimates how much cash is left over each month.

It then has charts to see what’s acceptable and what isn’t. For instance, with loans above $80,000, the VA would expect a household with four people and a Midwest location to have $1,003 in residual income for such costs as food, health care, clothing, and gas. If the same household was located in the West, they would need $1,117. 

USDA Financing

Borrowers might want to consider a USDA-guaranteed mortgage if buying a prime residence in a rural area. Such loans are backed by the US Department of Agriculture but originated by commercial lenders.

They require no money down and are tailored to rural and sometimes what-are-now outlying suburban areas. USDA financing represents about 1% of the mortgage marketplace. 

Non-conforming Mortgages & Non-government Backed Loans

Most mortgages today are government-backed. FHA financing operates under the authority of HUD, VA loans are part of the Department of Veterans Affairs, and USDA loans come from the Agriculture Department. Fannie Mae and Freddie Mac have been operated by the federal government since 2008.

There are, however, non-conforming mortgages. These loans are not created by government departments. Fannie Mae and Freddie Mac won’t buy them because they don’t meet conforming loan standards. 

It might seem as though non-conforming loans – about 11% or 12% of the market – are mortgages to stay away from. After all, they’re not the standard, everyday mortgages that most borrowers want. However, some non-conforming mortgages are entirely usable in certain cases.

For example, Redfin reported in mid-2023 that “nearly 1 in 10 U.S. homes are worth at least $1 million.” If you have a high-cost home in most areas, conforming and FHA financing may not be big enough to finance a transaction. The reason? Loan limits. 

If 10% of the market involves homes worth $1 million or more, there must be some way to finance them. The solution is the “jumbo” mortgage, financing that might be exactly like a conventional loan except that the amount of debt is bigger. 

Jumbo loans are one example of non-conventional financing and here’s another: the portfolio loan. With a portfolio loan, the lender – usually a bank – finances a home purchase that does not meet FHA, VA, or conforming loan standards. Maybe the debt is too big, or the down payment is too small. 

Since the loan does not conform to usual mortgage standards, it can’t be sold to Fannie Mae or Freddie Mac. If the loan can’t be sold, there’s no cash from a sale that might be used to originate new loans. Instead, the lender hangs on to the non-conforming loan until it’s paid off. The financing becomes part of the lender’s portfolio of assets and is thus known as a “portfolio” mortgage. 

Why would a lender make a portfolio loan? Think of a bank. It wants to sell a variety of financial services. Perhaps it can develop a relationship with a client by offering a non-conforming mortgage.

If you look at the range of financial products a bank might provide – savings accounts, CDs, checking accounts, retirement accounts, business loans, commercial financing, etc. – a portfolio loan might cement the business relationship a bank would like to establish.

Kirk Haverkamp

Kirk Haverkamp is an award-winning reporter and editor with more than 25 years of experience in journalism and public relations. He has contributed to Credit.com, Investopedia, and MetroMode online magazines, among other work. He has a B.A. in English from Hope College and a Master’s Degree in journalism from Michigan State University.

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