Historical houses in fall
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If you want to get a mortgage to buy a home but don’t have a big down payment, two federal programs can help make your dream a reality.

Both the Federal Housing Authority (FHA) and the United States Department of Agriculture (USDA) sponsor programs that guarantee home loans for people without a lot of cash; the idea is to encourage homeownership. But the loans work differently and they aren’t for everyone.

FHA and USDA loan basics

Both programs are administered through private lenders, just like regular mortgages. The government’s job is to guarantee that the loans will be repaid. That promise makes banks more likely to loan to people with limited incomes and savings.

Both programs guarantee conventional 15- and 30-year mortgages. Both make it easier for people who have declared bankruptcy to get a loan. And like regular mortgages, both limit the amount of a loan based on your income and other debt. That’s where the similarities end.

Different features, different requirements

FHA loans can be used for most properties anywhere in the United States, from big cities to suburbs and beyond. They require a credit score of at least 580 and a down payment of just 3.5 percent of the purchase price—far lower than banks would normally accept. There is no income limit, but the mortgages are generally for modest homes. Another plus: You can use “gift” money, such as from parents, for the down payment. Banks typically frown on gifts because they want owners to have their own hard-earned money in the property.

USDA loans are for homes in approved rural areas—but the definition of rural is broad and includes many developed suburbs. You can look up an address on the USDA eligibility website to see if it qualifies. Significantly, USDA loans require no down payment. But unlike FHA loans, there are income limitations. You can’t have adjusted income greater than 115 percent of the median for your county. For example, in 2018 a family of four in Boulder County, Colo. cannot earn more than $97,750 in adjusted income.

Mortgage insurance costs

Both types of loans carry hefty insurance premiums, which help offset the government’s cost of paying off bad loans.

An FHA loan requires an upfront insurance payment of 1.75 percent, which most buyers roll into the loan itself—thus increasing payments and interest. There also is an ongoing monthly fee that varies based on the loan but is usually under $100. Still, that adds up. USDA loans have a smaller upfront insurance payment—1 percent as of early 2018—but a higher monthly premium set at 0.35 percent of the loan.

In both cases, the premiums are considerably higher than conventional mortgage insurance. Moreover, those payments continue for the life of the loan; the only way out is to refinance. These insurance costs alone can often make a regular bank mortgage the better option, assuming you have enough savings for a down payment.

Owner occupancy is a must

Both programs also require owner occupancy—no investment or rental property—and frown on fixer-uppers. And in a competitive market, some sellers may be turned off by a buyer with a government-backed loan because it implies the person is “risky.”

Finally, consider if you really can afford a large loan that comes when borrowing all or most of the home’s purchase price. Saving more for a larger down payment will lower your monthly payments for years to come.