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What Is a Government Loan?

The U.S. government doesn't hand out "free money" to launch a business or cover personal expenses, but it does back several types of loans that can help you buy your first home, expand your business or earn a college degree, among other things. Follow along to learn more about how government loans work, what their benefits are and how the money can be spent.

How Do Government Loans Work?

When the government lends money to individuals, it usually doesn't do it directly. Instead, it guarantees those loans issued by banks, credit unions and other private lenders. This guarantee protects the lender if the borrower fails to repay the loan.

In some cases, however, a government loan does indeed come directly from Uncle Sam. For instance, the U.S. Department of Agriculture (USDA) might lend money directly to a farmer or rancher using money appropriated by Congress as part of the USDA budget. The USDA may issue and service the loan without help from a private lender.

Furthermore, a government loan may be subsidized or unsubsidized. For example, the federal government pays the interest on a subsidized student loan that's accrued while you're in school, but with an unsubsidized student loan, you're always responsible for paying the interest.

Why does the government support loans? The reasons include the potential to offer:

  • Lower interest rates compared with private loans.
  • Better odds of being approved versus private loans.
  • Capital for business owners who might not be able to secure it through private loans.
  • Flexible repayment and forgiveness plans.
  • No credit checks.

Types of Government Loans

Government loans serve an array of purposes. Here are five common types.

  1. Student loans: Several loan programs, including direct PLUS loans, Perkins Loans and Stafford Loans, help students or their parents cover college tuition and related expenses.
  2. Business loans: Several business loan programs, overseen primarily by the U.S. Small Business Administration (SBA), help businesspeople start or grow their enterprises, or recover from disasters. The most popular kind of SBA loan is known as an 7(a) loan.
  3. Home loans: Numerous mortgage programs for homebuyers and homeowners fall into this category, including federally backed home loans, disaster loans and home improvement loans. A popular type of federal housing loan is a mortgage from a lender approved by the Federal Housing Administration (FHA), otherwise known as an FHA loan.
  4. Agriculture loans: This category includes loans that help farmers and ranchers run or expand their operations.
  5. Veterans loans: The U.S. Department of Veterans Affairs (VA) offers several loan programs for military veterans who are homeowners or homebuyers.

What Are the Benefits of Government Loans?

Government loans may provide several advantages over private loans, but the benefits differ depending on the type of loan. Here are some of the benefits three common types of government loans have over private loans:

Student Loans

  • Interest rates for federal student loans are fixed and lower than those available on comparable private loans for many borrowers. Private student loans may come with a variable interest rate. Additionally, the interest rate applied is likely to be higher for borrowers with lower credit scores.
  • Payments for federal student loans aren't due until you graduate, leave school or switch to less than half-time status. By contrast, some private student loans demand payments while you're still in school.
  • For all federal student loans except PLUS Loans, no credit check is done. Some private student loans may require that the borrower have a credit history or secure a co-signer.

Business Loans

  • Proceeds from an SBA-guaranteed loan can be used for nearly any business expense, whereas a private loan can come with restrictions on how you spend the money.
  • An SBA loan likely will offer a lower interest rate than a private loan does.
  • You might be able to borrow more money with an SBA loan (as much as $5 million) than with a private business loan.
  • An SBA loan may give you more time (up to 25 years) to repay it than a private loan does.
  • If you're taking out an SBA loan of less than $350,000, you don't have to put up any personal collateral.

Home Loans

  • An FHA loan, one of the most common government-backed mortgages, may be easier to obtain than a conventional mortgage. You might qualify for an FHA loan with a FICO® Score as low as 500, while a conventional mortgage typically demands a FICO Credit Score of at least 620.
  • With an FHA loan, a down payment as low as 3.5% may be required, while a conventional mortgage typically requires a down payment of 5% to 20%.
  • The waiting period to qualify for an FHA loan after a foreclosure or bankruptcy normally is shorter than it is for a conventional mortgage.

Who Is Eligible for Government Loans?

Eligibility varies based on what type of government loan you're seeking.

For a federal student loan, a student must meet a number of criteria, such as being a U.S. citizen or eligible noncitizen, being enrolled in or accepted for an eligible degree or certificate program and maintaining "satisfactory" academic progress as measured by the school. With an SBA loan, you must be in business in the U.S., tap into other financial resources before trying to borrow money, and operate outside prohibited sectors such as gambling, lending and real estate investing.

Credit scores also may be an eligibility component on some government loans. You don't need to have even established a credit history to obtain a federal student loan, for example, but a federal FHA mortgage might be only available to borrowers with a FICO Credit Score of 500 or better.

Other requirements exist as well: VA loans, for example, require that you be a veteran, a veteran's spouse, or the surviving spouse of a veteran. You may also be eligible if you were previously a cadet attending the U.S. Military, Air Force or Coast Guard academy.

To figure out whether you qualify a government loan, visit GovLoans.gov.

What to Do if You Can't Get a Government Loan

There are many alternatives available to those unable to qualify for a government loan. For example:

  • Mortgage loans: If you can't get an FHA loan, you might qualify for a Fannie Mae HomeReady mortgage or a Freddie Mac Home Possible mortgage, both of which offer a down payment as low as 3%. Or, you can apply for other conventional mortgages from banks, credit unions and other lenders.
  • Student loans: Still searching for a student loan after not qualifying for a government loan? You might look into a student loan from a bank, an online lender or another private lender.
  • Small business loans: Did you strike out with a business loan from the SBA? Other sources of business financing include banks, credit unions, online lenders, crowdfunding platforms, credit cards, and even family and friends.

The Bottom Line

Government loans are options worth exploring when you need money to buy a house, start a business or go to college. Why? You might enjoy lower interest rates, less stringent credit requirements, more flexibility in paying off the debt and other benefits. Keep in mind, though, that loans from private lenders may supply advantages that government loans don't, such as less paperwork and faster approval. Therefore, it's important to weigh the pros and cons of a government loan and a conventional loan when you want to borrow money.