What is a secured mortgage loan?

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Secured loans are a staple of the mortgage market, and it’s easy to see why. Typically, lenders prefer buyers to buy a home with a 20% down payment, but many borrowers just don’t have the cash to meet that threshold with today’s home prices.

For borrowers who can’t achieve 20%, a secured mortgage can help. Here is what you need to know.

What is a secured mortgage loan?


Definition of secured mortgage loan

A secured mortgage is a home loan that a third party guarantees, or accepts responsibility for, in the event of default by the borrower. These types of mortgages are most often guaranteed by the government and are used to protect the lender when granting a loan to a borrower who does not make a substantial down payment or may present more risk.


How Secured Mortgages Work

While lenders look for a down payment to protect themselves in the event of default, they also want something else – to generate as many loans as possible.

Many borrowers, in simple terms, do not have the down payment necessary to qualify for a loan. In fact, according to the National Association of Realtors, the typical first-time buyer in 2019 bought a home with just 6% off, while repeat buyers put in 16% less, both below that ideal of 20%.

In short, without guaranteed mortgages, there would be far fewer home sales. Thus, lenders accept less money from borrowers who have a third party guarantee. The most common guarantors are the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA), which respectively support FHA loans and VA loans. The Department of Agriculture also guarantees USDA loans in eligible areas.

A point of distinction: the VA loan program is generally considered to be “collateral”, while the FHA loan program is considered more as “insurance”. From a borrower’s and lender’s perspective, however, they each provide third-party support that helps borrowers qualify for a loan.

Despite the lower down payment, secured mortgages must meet underwriting standards set by the lender and the third party. Lenders often have additional requirements beyond what the guarantor demands, a practice known as “layering”. For example, the FHA requires a minimum credit score of 580 to allow a borrower to put down only 3.5% less, but some lenders set the minimum higher, at 620.

FHA loans

The FHA loan program is popular for several reasons:

  • Borrowers can buy with as little as 3.5% down payment, provided they have a credit score of 580 or better. For borrowers with a credit score between 500 and 579, the program requires 10% upfront.
  • Borrowers can benefit from a debt-to-income ratio (DTI) of 43%; however, a large portion actually qualifies with a higher DTI, sometimes over 50 percent. This is due to “compensating factors”, such as cash reserves or a higher credit rating, which increase a borrower’s creditworthiness.
  • FHA interest rates are generally lower than conventional loans, which are not guaranteed or insured by the government.

However, because FHA loans are insured by the government, borrowers pay two insurance premiums: a premium, prepaid, equal to 1.75% of the loan principal; and an annual premium ranging from 0.45% to 1.05% of the balance, paid monthly. The annual premium can only be waived if you refinance another type of loan or fully repay your FHA loan.

VA loans

VA loans are available to eligible active duty members, veterans, and surviving spouses to help finance or refinance a home with no down payment – a benefit that can be used more than once. The VA as an agency guarantees a certain amount to a lender in the event of a defaults by a VA loan borrower.

VA loans give borrowers and lenders a lot of leeway. For example, the VA guidelines do not include minimum credit score standards or loan limits. Instead, lenders set their own credit score requirements and lend money as long as the borrower is financially qualified.

VA loans also have a residual income standard that helps lenders determine how much a borrower needs, after expenses, to qualify for a loan.

When purchasing or refinancing, VA loan borrowers must pay an upfront financing fee, although the fee may be waived under certain circumstances.

USDA loans

USDA loans are also available to low and moderate income borrowers with no down payment, but only in defined rural areas. (The term “rural” can be surprisingly broad, so check your area to see if it qualifies.)

A USDA loan has both an initial and annual fee, which is a percentage of the loan principal, in order to maintain the USDA collateral. These fees are charged to the lender, but generally passed on as a cost to the borrower.

At the end of the line

With secured mortgages, funds come from private sector lenders, but the loan is backed by a guarantor, usually a government agency, so lenders can qualify borrowers with limited down payment or a credit profile. riskier. The most common guarantors, the FHA, VA, and USDA, generally do not provide funding.

Buy a home with a secured mortgage and you’ll likely find more accommodating DTI ratios, lower credit score requirements, and, of course, smaller loan-to-value ratios. If you are considering a secured mortgage loan, ask a loan officer which option is best for you and what you are likely to be pre-approved for based on your credit and financial situation.

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