An Overview of Common Loan Programs
Christopher Shank NMLS 2562885
One of the most sacred obligations of a loan officer is the charge to inform the community at large about the industry they represent. To that end, today, we’re going to delve together into the four major loan programs that are out there. I hope you’re excited- here we go!
Programs, Products and Lenders
When I was little, one of my swimming instructors once warned me to closely examine the pool before I dive in headfirst. With that lovely piece of advice in mind, I feel it important to first explain the hierarchy in which residential mortgage loans in this country are structured.
In this country, there are four main families, or programs, of loans when it comes to residential lending: FHA, USDA, VA and Conventional. Each program is governed by separate authorities and structured according to its own set of guidelines and requirements, which we’ll get into in a little bit. For a particular loan to be able to claim membership within a specific program, it must adhere to those afore-mentioned requirements and be approved as such.
Within the umbrellas of each loan program, you have hundreds upon hundreds of different individual loan products backed by lenders. At their base, each of these loans must meet or exceed the minimum requirements for the program with which they represent. However, so long as these needs are met and their program permits, the lenders backing these products are free to impose their own restrictions upon their products and those who would seek to use them, so long as those restrictions themselves are not prohibited.
Let’s break this down into an example. The VA Loan Program does not, per program policy, identify a minimum FICO score that must be met in order to qualify for a VA loan. Because of that, there are lenders out there with VA loan products that do not require a minimum FICO score. By the same token, there are companies out there that do require a minimum FICO score, and per the VA Loan Program, they are free to do so.
When I work with clients, it’s this specific fact that I tend to spend most of my effort around. Full bias notification- I am the biggest fan of VA loans. That said, there are many, many different companies that are approved to put out VA loan products. When I pair my clients with a VA lender, I usually compare twelve or more lenders to ensure that I’m getting the right fit for my people.
Now, all that said, let’s delve into some programs!
FHA Loans
Prior to 1934, if you wanted to buy a home using a loan, you’d take yourself down to your local bank and jump through their particular brand of hoops. Unfortunately, with how few regulations governed banks back then, there was no unified measure as to what you needed to qualify for, or how. The biggest point of contention was risk management. If you borrowed money from the bank and failed to make your payments, the bank was out that money. Sure, they could take ownership of your house, but even then, they’re pretty much going to take a loss.
This changed in 1934, when the Federal Housing Administration built a loan program that would allow the government to assume some of the risk involved in the lending process by requiring that borrowers purchase mortgage insurance as a component of their loan. This way, should a borrower default on their agreement, the supporting financial institution still takes ownership of the property, but the spread of their loss is made up for using that insurance.
This worked swimmingly for the government, for in return for guaranteeing the financial positions of participating financial institutions, the government was able to keep a finger on the pulse of the housing market and adjust accordingly to ensure that it grew in a manageable direction.
The FHA Loan Program today is one intended to promote an equal opportunity for Americans to satisfy their dreams of homeownership. To that end, the FHA Loan Program is more forgiving (compared to other loan programs) of credit issues by setting a minimum FICO score of 500, establishing a comparatively high debt to income ratio (DTI) limit, and by allowing for tolerances when it comes to credit issues.
Another aspect of note with this loan program is the requirement for Placed Mortgage Insurance (PMI). As introduced a few paragraphs ago, the FHA requires PMI on every FHA loan, regardless as to the amount of that loan, for the life of said loan.
As a loan officer, I usually find FHA loans more ideally suited for first-time homebuyers and those buyers who have some financial challenges in their recent history. Many community nonprofits and government entities operate down-payment assistance programs to offset the down-payment requirement of FHA loans, which greatly reduces the financial burden of these specific types of buyers.
Due to the fact that PMI remains in place for the life of the loan, I regularly see folks secure their first house with an FHA loan and then refinance under another program (usually Conventional) once they have built up enough equity to make such a shift financially advantageous.
USDA Loans
As it turns out, financial institutions across the nation really liked the idea of the government stepping in and assuming the biggest source of risk when it came to providing home loans to Americans. Because of this, it’s probably not too much of a surprise that in 1937, the United States Department of Agriculture rolled out its own home loan program. Initially targeted exclusively at farms as a way to help our nation’s farmers recover from the great depression, the House Financing Act of 1949 introduced the USDA rural development loan intended to incentivize the growth of this nation’s rural communities.
Unlike the FHA, the USDA does not require their borrowers to pay for mortgage insurance; if a borrower defaults, the USDA is on the hook for covering the spread of that borrower’s debt to their financial institution. Instead, the USDA charges an upfront fee (as of 2024, 1% of the total loan amount) to offset their risk, and an additional .35% of the principal value until that principal is less than 80% of the structure’s value.
Due to the risk that the USDA takes on for this loan program, and because the benefits of this loan make it an ideal candidate for abuse, the USDA has put some serious restrictions as to who can qualify for a USDA loan.
For starters, the USDA has a strict DTI threshold designed to reduce the risk of borrowers buying a house that they cannot afford. As this loan is intended for low-to-moderate income families, there are household income caps that prevent applicants from qualifying if their income is above a specific amount. Additionally, in addition to the applicant qualifying for a USDA loan, the property they wish to purchase must also meet the USDA’s guidelines (the primary requirement being that the property must be located in a rural area).
Due to the above restrictions, it’s actually a bit of a challenge for some folks to secure USDA financing. For those that do qualify though… the benefits are definitely worth it. Full disclosure- I love USDA loans. Zero dollars as a down payment is hard to beat, but it gets better when you realize that most USDA loans have more favorable interest rates than similarly structured loans of other programs. Surprisingly, the USDA has not established a minimum FICO score requirement, but in practice, I’ve found this offset by the rather strict DTI requirement mentioned in the previous paragraph.
As a loan officer, I try my hardest to qualify my clients for USDA loans. 97% of this nation’s land is rural, which means that if my client isn’t living within city limits, there’s a fair chance that their property is USDA eligible, and that’s half the battle won already. As I identified above, the benefits are definitely there. As an added (and rather personal) bonus, a good number of loan officers shy away from USDA loans due to its various challenges. This means that when it comes to my USDA loan qualification (with its $0 down payment and .30 lower interest rate) competing with whatever the competition is offering, my client is the one who really wins that one.
VA Loans
Believe it or not, but when our fighting forefathers campaigned across a war-torn Europe or island hopped through the Pacific theatre, they found themselves in a land devoid of souvenir shops or Burger Kings. This meant that upon their victorious return, we had a lot of veterans want nothing more than to start a family and find something to do with years of backpay.
In 1944, our government introduced the Servicemen’s Readjustment Act, contained within was the foundations which would become the VA Loan Program that we all (especially me) know and love.
The intent with the VA Loan Program is to ensure that our veterans and active duty folks are allowed every opportunity to secure a home as part of that American Dream that they so valiantly earned. The VA Loan Program accomplishes this by specifically building channels with which to account for disability pay, requiring no minimum down-payment for VA homebuyers, and by refusing to set a minimum FICO score or maximum DTI ratio.
Additionally, the VA Loan Program allows for the financing of multi-family dwellings under a VA loan, so long as one of those units is used as a primary residence by the buyer for at least one year. This alone has allowed for more than a few VA loans to form the foundation for sizable real estate empires.
Unfortunately, there is a lot of misinformation out there about this specific loan program that just aren’t true. Through my adult life, I’ve heard things such as “the VA loan has a minimum credit score” [FALSE], “VA loans take longer to finance than other loan programs and are therefore less competitive” [VERY FALSE], and even “you can only have one VA loan and then you’re done” [FALSE]. The reason behind this unfortunate trend is simple- it’s a matter of numbers. Even though 70% of Clarksville’s annual loan volume is comprised of VA loans, only around one in twenty Americans is a veteran. Thankfully, since 2012, there have been stronger efforts by the Department of Defense to educate servicemembers about the benefits they have earned, but there’s a long road ahead. My advice, if you’re curious about this loan type, is to find yourself a loan officer who specializes in this loan type and quiz them until they’re blue in the face. There’s a LOT of material in the VA’s lender guide…
If you can’t tell by now, I’m a VA loan groupie. In fact, due to my financial situation at the time of its purchase, the house that I call home right now could not have been financed under any other loan program. As a loan officer, there are very few reasons why I would not advocate for a VA loan if I am working with a veteran client- the benefits of this loan type are simply too strong to allow for competition from the other three programs.
Conventional Loans
The first three loan programs that we discussed earlier are all administered and backed, in some way or form, by government entities. Conventional loans, on the other hand, are governed by the government-sponsored entities (GSE) Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FMCC); Freddie Mac and Fannie Mae, for short.
Unlike the FHA, USDA, or VA, Freddie Mac and Fannie Mae don’t provide direct security to financial institutions in the form of PMI or funding fees. Instead, these two GSEs protect lenders and secondary investors by establishing rules with which loans must abide by, if they are to be sold on the secondary market in the first place.
In essence, conventional loans are the same loans that existed before even the FHA Loan Program started up. These types of loans are financed by various lenders and financial institutions, and those institutions are themselves responsible for assuming the risk of borrower default (although this risk is usually offset by mortgage insurance).
Because there are fewer base regulations that govern these kinds of loans, the world of conventional lending is vast; limited only by the risk appetites of each particular lender.
As a rule of thumb, I advise my clients to expect to come to the table with a FICO score of at least 620 when considering a conventional loan option. Past that, though, their specific needs and situation dictate the direction that I take them in when it comes to finding a lender. For example, I have a lender who specializes almost entirely in DSCR loans (and therefore has less of an appetite for primary dwelling loans). On the other hand, I have a lender whose rates are usually a little higher than average, but their manual underwriting department is massive, which means they’re more likely than some other lenders to want to take on a client with a unique situation or credit history.
As a loan officer, I use conventional loans primarily for investment properties and for folks who are no longer first time homebuyers. While there’s nothing wrong with running a conventional loan for someone’s first house (especially if that person has a fantastic financial foundation), I first aim to park them in a VA, USDA, or FHA loan if it’s in their best financial interest. Still, I find myself rather excited when my initial review indicates a high likelihood toward conventional financing because each person’s unique situation often gives me an opportunity to vet new lenders to work with, and who doesn’t like meeting new people?
