Are government loans easier to get?

The promise of FHA, VA and USDA loans has always been fairly simple: Getting approved for one is easier for those who might encounter issues with mortgage programs that have tougher standards. By backing these loans, the federal government is making the dream of owning a home more accessible to buyers who otherwise might not be able to qualify for a conventional mortgage.

Statistics from the Home Mortgage Disclosure Act (HMDA), however, tell a slightly different story. In the third quarter of 2023, applications for FHA, VA and USDA loans all received denials at a higher rate than conventional loans.

If they’re supposed to be so much easier to get, what’s up with all the rejections? Let’s look more closely  at how government-backed loans work and how lenders review applications — all the better to to prepare for the process of applying for one.

Key terms

Government-backed loan: A government-backed loan to buy a home doesn’t actually involve borrowing the money from the government. Instead, the government sponsors programs that guarantee or insure the mortgage: The lender of the money, a private bank, credit union or mortgage company, will be reimbursed all or part of the outstanding balance if the borrower fails to make payments. FHA loans, VA loans and USDA loans are all government-backed mortgages. These all have varying requirements, but generally, they are good bets for borrowers with less-than-perfect credit and low or moderate incomes.

Conventional loan: Conventional loans are not guaranteed by the government. Instead, they are both originated and backed by a private sector lender, which bears all the risk for them. They primarily include conforming loans (those that adhere to limits set by the Federal Housing Finance Agency), which require a minimum credit score of 620 and a down payment of at least three percent of the purchase price. However, they also include non-conforming products like jumbo loans and non-QM loans.

How is a government loan easier to get?

Also known as guaranteed mortgages, government-backed loans can be “easier” to get in two principal ways:

• They do not require borrowers to have excellent credit
• They do not require borrowers to have a lot of cash

Creditworthiness: While conventional loans require credit scores solidly in the “good” range – in the 600s at least – the government-backed mortgages will consider applicants with credit scores that are lower, qualifying as just “fair.” FHA loans, for example, carry stated minimums of 580 or 500, depending on your down payment.

Additionally, some government-backed loans will approve borrowers with significantly higher debt-to-income ratios than conventional loans. This means that even if you’ve got a sizable chunk of regular monthly payments – student loans, a car loan and credit cards, for example – you may still be able to add on your mortgage payment and get approved.

Coming up with cash: Government-backed loans are more lenient when it comes to down payments, accepting smaller amounts — if any: VA loans and USDA loans, for example, typically do not require a minimum down payment at all. In contrast, with conventional loans, 20 percent of the home’s purchase price remains the norm (while some lenders will take less, they will then charge you private mortgage insurance — essentially an extra monthly fee).

As a result, government-backed loans are often seen as a good option for young first-time homebuyers, who aren’t sitting on a pile of cash or have the most sterling credit scores.

Are government loans better for borrowers with past credit troubles?

Government-backed loans are easier to get if you have faced major financial difficulties in the past.

“Borrowers who have had events like foreclosures, short sales or bankruptcies will find government programs typically have a much shorter waiting period to qualify for a new loan than conventional programs,” says Darren Tooley, senior loan officer at Cornerstone Financial Services in Southfield, Mich.

For example, while conventional loans may have a seven-year waiting period if you had a past foreclosure, Tooley says that FHA loans have a standard three-year waiting period, while VA loans have a two-year waiting period. Plus, both of those can be shortened to just one year with “extenuating circumstances,” according to Tooley.

The same goes for bankruptcies: While it varies depending on the way you file, the waiting period for a government-backed mortgage application is generally half (one to two years) that of a conventional mortgage (two to four years).

Government vs. conventional mortgages at a glance

How can a government loan be harder to get?

Despite all the ways that government-backed loans appear to be easier to get, approval is by no means a guarantee. These mortgages have some of their own particular stumbling blocks.

• FHA loans: Matt Dunbar, senior vice president of the southeast region at Churchill Mortgage, says that FHA loans often see higher denial rates to more comprehensive evaluations of a borrower’s ability to manage their mortgage payments. “Additionally, FHA loans include mandatory mortgage insurance regardless of down payment size, increasing monthly costs and impacting overall loan affordability,” says Dunbar. Another key sticking point: You’re probably not going to be able to borrow as much. The limit for FHA loans on single-family homes in most areas is currently $498,257 – certainly not a small amount of money, but it can pose challenges in an expensive housing market. (In contrast, conventional conforming loans go up to $766,550 in most areas.)

• VA loans: Denial rates for VA loans are the lowest of all government-backed loans, and they are only slightly higher than conventional loans. Still, getting one is limited solely to service members, veterans and eligible spouses. So, the pool of applicants is much smaller. VA loans also have their own special paperwork: Borrowers have to obtain a certificate of eligibility (COE) and there are complicated rules about entitlements. Also, you can only buy a single-unit, primary residence with a VA loan (unless you aim to reside in one part of a multi-unit property).

• USDA loans: In addition to finding a home that meets the USDA’s definition of “rural”, there are loads of reasons that borrowers can encounter issues with approval. One surprising one: You make too much money. Guidelines cap household income at no more than 115 percent of area median income, which can pose trouble if you’re earning a decent chunk of cash.

Additional lender standards

Another reason that government-backed loans can be tricky: The criteria could change on you. “Since government-backed mortgages offer leniency with factors like minimum credit scores and higher debt-to-income ratios, they can carry high amounts of risk” for the lender, says Tooley. It can’t sell these loans to Fannie Mae or Freddie Mac, for example (though the Government National Mortgage Association, a federal corporation colloquially known as Ginnie Mae, does buy them). And, despite the federal promise of compensation, some lenders just might not feel comfortable accepting applicants with lower credit scores or a high amount of debt.

So, while the government sets guidelines for the loans, lenders can go a step beyond, imposing their own criteria called overlays. “An overlay is an extra guideline or requirement that lenders add on top of the standard rules set by government-backed programs like FHA, VA and USDA loans,” says Greg Clement, founder and CEO of real estate investing software firm Realeflow. “For instance, the FHA might accept a credit score as low as 580 for a 3.5 percent down payment, but many lenders might require a minimum score of 620 or even higher.”

Some lenders use overlays, while others simply stick to the government’s directives — evidence of the importance of shopping around, according to Jennifer Beeston, senior vice president of mortgage lending at Guaranteed Rate Lending, which offers government-backed loans.

“If you are turned down for a FHA or VA loan, it is always good to check with another lender, as you may have been turned down because of a made-up lender guideline that another lender will not have,” says Beeston. (Guaranteed Rate does not impose overlays on FHA or VA loans, she notes.)

What other factors make a government loan harder or easier to get?

If you’re in a rush to get to closing

Buying a home always takes a long time, but getting the clear-to-close call for a government-backed loan can take even more time, according to Dunbar.

“The application process for government-backed loans typically requires more documentation and incurs longer timelines than conventional loans,” says Dunbar. “This complexity stems from the need to rigorously assess both the borrower’s financial stability and the property’s compliance with specific program standards.”

If the home you want to buy isn’t in great condition

Outside of your own credit history and financial profile, the condition of the home you’re trying to buy can have an impact. Government-backed loans have a reputation for having pickier appraisals and inspections.

“FHA loans mandate thorough appraisals to ensure properties are safe and structurally sound, complicating approval for older or fixer-upper homes,” says Dunbar. “The FHA 203(k) program addresses this by financing both the purchase and necessary renovations, albeit with a rigorous inspection process. VA and USDA loans impose their own sets of restrictions, such as primary residence requirements and rural area stipulations, which may limit buying options.”

Of course, issues with a property’s livability aren’t confined to government-backed mortgages, as Tooley points out. “Although there are some other nuances where FHA appraisals could be considered stricter than those required for conventional mortgages, it’s important to remember that conventional mortgages also have appraisal standards,” he says. “For the most part, items considered a ‘health and safety issue’ on an FHA appraisal will most likely come up on a conventional appraisal as well.”

Still, the government-backed loan tends to require problems to be fixed before funds can be issued, and might even mandate a second inspection.

If you’re refinancing

So far, we’ve discussed purchase mortgages — loans to buy a home. While the first time around can be a stressful marathon to closing day, it’s never too soon to think ahead, about refinancing. And refinancing a government-backed mortgage can be a much faster and easier process than refinancing a conventional loan, which is essentially getting a new mortgage.

FHA streamline refinances, for example, often don’t involve a credit check, income verification or property appraisal. A VA IRRRL – that stands for Interest Rate Reduction Refinance Loan – comes with the same perk of much less paperwork. Both of these options are only available to current holders of FHA and VA loans. So if you’re buying when rates are high, and think a refi is in the probable future, that’s a point for a government loan today.

Bottom line on conventional vs. government-backed loans

Government-backed mortgages, like FHA, VA and USDA loans, can be a better pathway to purchase a home if your credit isn’t perfect or you don’t have a significant amount of money to put toward a down payment.

On paper, anyway. Some lenders may overlay their own terms that make the government-backed loan’s criteria basically the same as a conventional loan’s. Even if they don’t, these mortgages are no slam dunk. Applying for a government loan can be very challenging, and you’ll need to be prepared for a long process that will entail a lender taking a thorough look at every dollar that comes into your bank account and every dollar that comes out of it.

So don’t assume anything. And as you shop around, compare offers on both types of loans, examining every detail from interest rate to closing process. Despite the hype, the easiest mortgage for you to get may not be the obvious one.

FAQ

• How do interest rates compare between conventional and government loans?

  Lenders set their own interest rates for all types of loans, but in general, rates are fairly similar between conventional and government-backed loans. As of May 29, Bankrate data shows that average interest rates for 30-year FHA loans (7.12%) were slightly lower than those of 30-year conventional loans (7.17%), while rates for 30-year VA loans ran slightly higher (7.27%).
  
  
  When comparing options, however, it’s more important to look at the APR (interest rate coupled with additional fees) to get a true picture of the loan’s cost. Sometimes the mortgage insurance premiums associated with an FHA loan, for example, can make that mortgage more expensive than its conventional cousin.
  

• What’s the easiest loan to get?

  No mortgage is all that easy to get – lenders have a lot on the line when they agree to hand out hundreds of thousands of dollars. However, FHA loans are a better option if you’re worried about having less-than-perfect credit and/or not much money to contribute to a down payment. Underwriting standards for FHA loans in particular may allow for a higher debt-to-income ratio and a credit score well below 600. Additionally, FHA loans do not have any additional eligibility requirements such as the need for military affiliation (like VA loans) or rural location (like USDA loans).