What are the Different Types of Government-Backed Loans?

Posted on by
woman sitting in front of the Capitol building learning about the different types of government backed loans

When you need to borrow money to buy a home or finance your education or business, government-backed loans may come with more favorable terms and rates, especially for people with fair credit. However, they also have eligibility requirements and can only be used for certain things. Here’s what you need to know.

What Is a Government-Backed Loan?

Government-backed loans are insured by the federal government, which offers protection for the lender in the event that the borrower defaults. Because these loans reduce the risk of lending, lenders are able to provide lower interest rates and more favorable terms, such as lower down payment requirements for mortgage loans and subsidized interest for student loans.

Most government-backed loans aren’t issued by the federal government directly. They’re offered by banks, credit, unions, and other private lenders, and not all lenders offer them. There are also various eligibility requirements associated with each type of government-backed loan.

How Do Government Loans Differ from Private Loans?

There are several key differences between government loans and private loans.

  • Private loans are not insured by the government
  • Private loans tend to come with higher interest rates, but that’s not always the case for people with excellent credit
  • Some government loans come with other perks, such as:
    • Easier credit requirements or no credit check
    • No prepayment penalties
    • Flexible repayment plans
    • Partial loan forgiveness (in the case of student loans)
  • Private loans are more widely available
  • Government loans have different eligibility requirements
  • The process of obtaining a government loan is often more time-intensive

Government-Backed Housing Loans

FHA Loans

FHA loans are insured by the Federal Housing Administration. These loans come with lower down payments and fewer closing costs, and they’re also easier to qualify for if you have fair credit. A traditional FHA mortgage must be used for your primary residence, but you can purchase a multi-family home with up to four units. Other requirements include:

  • A minimum FICO score of 580 to qualify for the low 3.5 percent down payment option
  • A minimum FICO score of 500 to qualify for the 10 percent down payment option
  • A debt-to-income ratio of less than 43 percent
  • Proof of steady income and employment

You’ll also be required to pay a mortgage insurance premium to the FHA for either 11 years or for the life of the loan, depending on the term of the loan and how much you borrow.

In addition to traditional FHA mortgages, the FHA insures several other types of loans:

  • Home Equity Conversion Mortgage: Available through FHA-approved lenders, this reverse mortgage program allows seniors age 62 and older to tap the equity in their homes, either as a monthly payment or line of credit, while keeping the title to the property. Seniors still need to pay mortgage insurance premiums, origination fees, servicing fees, and closing costs for this type of loan.
  • FHA 203(k) Rehabilitation Loan: With a section 203(k) loan, you can borrow to make improvements on your existing residence or to cover the purchase or refinance of a home in addition to the cost of its rehabilitation. For improvements and repairs that don’t require structural alterations, you can borrow up to $35,000 with a limited 203(k) loan. A major renovation will require a standard 203(k) loan, which has higher borrowing limits and a minimum loan amount of $5,000. You’ll need to hire an approved consultant to oversee the project with a standard 203(k) loan.
  • FHA Energy Efficient Mortgage Program: Similar to an FHA 203(k) loan, this program helps homebuyers pay for energy-efficient improvements by borrowing more than the amount needed for purchasing or refinance. The borrower needs to get a home energy assessment to be eligible.
  • Section 245(a) Loan: These loans are designed for borrowers whose incomes will grow. With a graduated payment mortgage, monthly payments start low and increase gradually. These loans help limited-income borrowers that expect an earnings increase to qualify for a loan sooner. Growing equity mortgages also have growing monthly payments, but they are designed to help borrowers pay off their mortgages sooner.

To find the best loan for your financial situation, consult your mortgage lender for details.

USDA Loans

USDA loans are insured by the U.S. Department of Agriculture. They are designed for low-to-moderate income residents of rural areas with a population of less than 20,000 who are purchasing a primary residence. Interest rates are some of the lowest available with any loan, and there’s an option for a $0 down payment. However, borrowers will need to pay an upfront mortgage insurance fee and ongoing premiums. And most lenders require a FICO score of 640 or above. The USDA offers a tool to check your eligibility for this type of loan.

VA Loans

The U.S. Department of Veterans Affairs guarantees a portion of these loans, which are only available to servicemembers, veterans, and their families. They come with some of the most attractive rates and terms available to borrowers. There’s no down payment required, no mortgage insurance premiums or private mortgage insurance, some of the lowest interest rates available, fewer closing costs, and no prepayment penalties. Each lender has their own eligibility requirements, but most require a credit score of 640 or higher and a debt-to-income ratio of 41 percent or less.

The VA also guarantees the Native American Direct Loan program (NADL), which helps Native American veterans access 30-year, fixed-rate mortgages to purchase, build, or rehabilitate a home on Federal trust land. These loans come with similarly favorable terms and interest rates.

Government-Backed Education Loans

Federal student loans are issued by the U.S. Department of Education. Typically, these loans offer fixed interest rates that are lower than with private loans, and there’s no credit check or cosigner requirement with direct subsidized or unsubsidized loans. Furthermore, you don’t need to begin repayment until after you graduate or drop below half time, and if you’re struggling to make your payments after graduation, you have options. It’s also possible to have a portion of your federal student loan debt forgiven entirely if you work in certain jobs or complete a term of service.

To apply for federal student loans, you’ll need to fill out the Free Application for Federal Student Aid (FAFSA). You may be eligible for the following types of loans:

Direct Subsidized Loans

Students who demonstrate financial need may be eligible for direct subsidized loans, which are the most attractive option for federal student aid. These loans come with a fixed 2.75 percent interest rate for the 2020-21 school year, and the U.S. Department of Education pays all interest while you are in school, for six months after you graduate, and during periods of deferment.

Direct Unsubsidized Loans

These loans also come with a fixed 2.75 percent interest rate (4.3 percent for graduate borrowers), but you’ll be responsible for paying all the interest. You can still avoid making payments while you’re in school full-time, but interest will accrue and be added to the principal. These loans are available to all students, regardless of financial need.

Direct PLUS Loans

These loans are designed for graduate students or parents borrowing on behalf of their children. Unlike with direct subsidized and unsubsidized loans, you need to have good credit or meet additional requirements to qualify for these loans. The maximum amount you can borrow is the cost of the program less any other aid you receive. The loan fee for PLUS loans is more costly than for direct subsidized and unsubsidized loans, and the interest rate for the 2020-2021 school year is 5.3 percent. If you have excellent credit, it’s possible to get a lower interest rate from a private lender.

Direct Consolidation Loans

If you have multiple student loans from different loan servicers, you may be able to combine them free of charge with a direct consolidation loan. This will give you a single monthly payment with an averaged interest rate.

Government-Backed Business Loans

SBA 7(a) Loan

7(a) loans are the most common SBA loans issued to small businesses, a portion of which are guaranteed by the Small Business Administration. This guarantee helps businesses access capital when they might otherwise not qualify for funding. The SBA sets a maximum interest rate based on the prime rate, loan size, and term. There are several different types of 7(a) loans that serve different industries. Terms vary, but most 7(a) loans come in amounts up to $5 million and are repaid over 10 years.

SBA Microloan

These loans come in amounts up to $50,000 and are available to small for-profit businesses along with non-profit childcare centers. The Small Business Administration loans money to intermediary non-profit lenders, which in turn issue loans to small businesses. The maximum repayment period is six years, and interest rates vary but typically fall between eight and 13 percent.

The credit requirements for these loans are less stringent than with other business loans, but intermediaries often require a minimum FICO score of 575. To get an SBA microloan, you typically have to put forth collateral and show your ability to repay the loan with current cash flow or financial projections. You’ll also need to submit a business plan.

Disaster Relief Loans

The SBA provides low-interest loans to small businesses and homeowners who have been impacted by a declared disaster in their area. These help with losses not covered by insurance. There are several types of disaster relief loans:

  • Physical damage loans: These cover the repair or replacement of property or equipment damaged in a disaster
  • Mitigation assistance: This helps small businesses cover their operating expenses after a disaster
  • Economic injury disaster loans: Small businesses and nonprofits that have sustained damage to their personal property or home may be eligible for this loan
  • Military reservist loan: This helps with operating expenses while employees are on military leave
  • COVID-19 EIDL: These loans provide working capital and operating expenses to businesses adversely affected by the coronavirus pandemic

Other Types of Government-Backed Loans and Programs

When to Use a Government-Backed Loan

If you’re eligible for a government-backed loan, you may find that you can get more favorable rates and terms than with a private lender, especially if you have fair credit. However, that’s not always the case. For example, some private lenders are able to offer loans with interest rates below that of Direct PLUS loans, and you may pay less overall with a conventional mortgage if you’re able to make a 20 percent down payment because you’ll be able to avoid mortgage insurance.

One instance when you should always choose a government-backed loan is if you’re offered direct subsidized or direct unsubsidized student loans from the U.S. Department of Education. The low interest rates beat those of private student lenders, and you’ll be able to request deferment or possibly even forgiveness if you use these federal loans to finance your education.

Keep in mind that government-backed loans can only be used for the specified purposes, so if you need a loan to fund your wedding or buy a new refrigerator, you may consider going through a private lender to take out a personal loan. And if you need funds quickly, borrowing from a private lender may better suit your needs.

When deciding between loan options, compare rates across multiple lenders to find the best deal. And always calculate the total cost of borrowing and weigh factors such as prepayment penalties before signing on the dotted line.

The information contained herein is provided for free and is to be used for educational and informational purposes only. Consult a financial professional for specific help with your situation.

Are you looking for a loan?