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Chapter 13. Government Loans

┠What are government loans?

┠What is an FHA loan?

┠What is the major advantage of an FHA loan?

┠What are the disadvantages of an FHA loan?

┠What are the major FHA programs?

┠What is a VA loan?

┠How do I find out if I am eligible for a VA mortgage?

┠Can VA loans only be used to buy a home?

┠Can a seller refuse to sell to people using FHA or VA loans?

What are government loans?

There are two types of government mortgage loans that must be addressed — FHA loans and VA loans. Farm loans are not discussed, as they are specialized, and if you are looking to finance the purchase of a farm, you should seek advice from a local bank near the farm.

The government mortgage loans are not really loans from the government. Instead, a government agency insures or guarantees a loan made by a private lender. These are loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA).

The purpose of these governmental programs is to facilitate home ownership for those moderate- or low-income families who do not have the ability — usually the down payment — to qualify for a conventional loan. The insurance or guarantee takes away the lenders' risk of loss, allowing them to make loans with as little as 3% down for FHA-insured loans and zero down for VA guaranteed loans.

What is an FHA loan?

The FHA does not make loans, but rather insures the lender against loss that may occur if the property is foreclosed upon and the sale does not cover the amount owed. The FHA insures lenders against loss from making loans that have a higher risk of default than the lender would accept without the insurance. For purposes of simplicity and because of its common terminology, these FHA-insured loans are referred to as FHA loans.

What is the major advantage of an FHA loan?

The major advantage to the borrower has changed in recent years. At one time, the low down payment was the major advantage. Now, the major advantage in qualifying for a loan is that FHA standards for approving a borrower for loans requiring little or no down payment are more liberal than those of conventional lenders.

When qualifying a borrower's income, FHA allows coborrowers who do not occupy the property to have their income count in the qualification process. FHA also allows gifts for closing costs that conventional lenders would not.

What are the disadvantages of an FHA loan?

There are three major disadvantages of FHA loans. First, there is a mortgage limit that excludes many homes. The lending limit is set by area, with higher limits in states with higher home costs. As of October 2007, the lowest maximum limit was $200,160. The highest was $362,790. Although this covers many homes, it obviously also excludes many.

You must remember that the purpose of these loans is to allow low-income borrowers a chance at home ownership. Low-income borrowers buy the least expensive homes. They may cost less because of size, location, need for repair, or a combination of these factors.

The second disadvantage is that selling a home to a buyer using an FHA-insured loan may cost the seller more money than if the buyer used conventional financing. The seller may be asked to pay points, which is allowed under FHA rules. This does not happen with conventional financing. This was a more serious problem when the buyer was allowed by law to pay only one point. The FHA buyer may now pay all the points. The time involved to close is longer than with conventional loans. Even with automated underwriting and more authority given to lenders to qualify borrowers, it still could take forty-five days to process an FHA loan. Sellers will tend to accept a buyer who will finance conventionally over an FHA buyer.

The third disadvantage to FHA loans is the mortgage insurance premium (MIP). This is the FHA equivalent of the conventional loan's private mortgage insurance (PMI). The cost for MIP is higher than PMI.

FHA-insured loans work best for low-priced homes when the buyer cannot get conventional financing. When there are many buyers and few homes for sale (a seller's market), fewer homes are sold through the FHA. When there are few buyers and many homes for sale (a buyer's market), more FHA financing is used.

The advice is simple. If you can qualify for a conventional loan at a standard rate, you are better off getting a conventional loan than getting an FHA loan. If you must pay a substandard (higher) interest rate, higher points, and so on because of credit or income problems, FHA may be your answer to home ownership.

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