It is the most feared phrase in the English language, Ronald Reagan famously said:
"We're from the government, and we're here to help."
If government aid is evil, there are certainly some exceptions. Home mortgages insured by the Federal Housing Administration have helped put more than 34 million Americans into their own homes since the since the 1930s. Millions more have benefited from zero-down VA loans from the U.S. Department of Veterans Affairs and from the Department of Agricultures Rural Development loans. Mortgage guarantees and down payment assistance are also doled out by municipalities and state programs such as California's Housing Finance Agency.
It's hard to generalize about their pros and cons with so many government-enabled loans out there. But when we compare them to conventional (non-government) loans, a few observations arise.
FHA loans normally demand higher interest rates than conventional mortgages because of the increased risk of default. The "spread" between FHA and conventional loans can be as high as a point, or 1 percent, which is a lot. Borrow $200,000 for 30 years at 5 percent fixed and you'll pay $1,073 monthly. Make it 6 percent and you'll pay $1,199. It's an extra $45,360 over 30 years.
Why have so many buyers chosen FHA loans? Not because they like higher interest. It's about lower down payments. An FHA-backed loan today can be had for about 3% percent down, even by someone without stellar credit. The same borrower might be asked for 20 percent down by a lender without the FHA guarantee.
But there are complicating factors. FHA borrowers must pay an upfront fee of 1.5 percent of the loan amount, plus an annual insurance premium of 0.5 percent. That premium is about the same as what's paid by a conventional borrower who must carry Private Mortgage Insurance (PMI).
A higher-interest-rate FHA mortgage may cost less in the long run than a conventional mortgage with PMI, but there is no overarching rule. You have to run the numbers and compare. For many borrowers, the deal "maker" or "breaker" won't be the interest rates or monthly payments. For many, with conventional lenders now demanding 10 or 20 percent down, it's all about down payments.
In theory, it's possible to avoid PMI with a piggyback mortgage structure - by borrowing 80 percent of the property value in one loan and 10 percent on a second for example. (This trick was common in the loose-lending days of old but today (in 2009), it's much harder to find second-position lenders at loan-to-value ratios like these.
Two other brands of government-guaranteed loans are offered by federal agencies. The Department of Veterans Affairs will insure zero-down, 100 percent financing as a benefit to military veterans (even if they served in peacetime). The interest rates are similar to FHA loans.
Zero-down financing is also backed by the U.S. Department of Agriculture under its Rural Development program. The audience for RD loans is limited. They're intended to help low-income people buy, build or renovate homes in rural areas. Houses must be modest in size, design and cost, according to the agency. The interest rates are similar to FHA and VA loans, combined with 100 percent financing. Great terms for the needs of many people if they qualify.