Types of Mortgage Loans
Before you first enter the world of homebuying, you may think there’s only one type of mortgage. But once you begin the process, you’ll quickly learn that there are numerous types of mortgage loans, each with their own set of pros and cons.
As you begin the homebuying process, here are the various types of mortgage loans available to you.
Ideal for: Home buyers with strong credit
Conventional loans are the most popular type of home loan, so nearly every mortgage lender offers them. They’re a traditional home loan that’s also referred to as a conforming loan, since it conforms to the standards of the government entities Fannie Mae and Freddie Mac. However, these loans are not backed by the government.
Good or excellent credit is usually required to qualify. While a 20% down payment used to be the rule of thumb for conventional loans, many lenders now accept much less from borrowers with great credit, minimal debt, and a steady income. But if you put down less than 20%, you may have to pay private mortgage insurance (PMI) until you hit 20% equity in the home.
Conventional loans come in two main types. The first is fixed rate, which has the same interest rate for the life of the loan and is usually offered for terms of 15 years or 30 years (though some lenders offer additional terms). The second type is adjustable-rate mortgage (ARM), where the interest rate is set at the beginning — and often lower than a fixed-rate loan — but then becomes variable, and can go higher or lower depending on market conditions.
Ideal for: First-time home buyers or those with less-than-perfect credit
FHA loans are fixed-rate, government-backed loans that are ideal for first-time homebuyers who don’t have much cash to put down or lack strong credit. The Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development, insures these loans. You apply for them through a financial institution like your bank, but since they’re backed by the government, the lender can give you a better deal than on a conventional loan. Note that not all financial institutions are qualified to offer FHA loans.
FHA loans are appealing to young or newer buyers since they require a down payment as low as 3.5% for those with credit scores of 580+, and 10% down with credit scores of 500-579. This means the borrowing criteria and credit requirements are looser than with conventional loans. In exchange for these perks, you have to pay for mortgage insurance, also known as a premium. With an FHA loan, you’re required to pay an upfront premium of 1.75% of the loan amount, plus an annual premium of .45% to 1.05% that is actually included in your monthly payments. These premiums are for the life of the loan, unless you put down a 10% down payment, in which case the premiums disappear after 11 years.
Ideal for: Former or current military service members
Much like FHA loans, VA loans are backed by the government, but offered through mortgage lenders. The Department of Veteran Affairs insures part of the loan, which allows lenders to have excellent terms, though not all lenders offer VA loans. The key benefit of VA loans are that there is typically no down payment required, and interest rates are usually lower than conventional loans. Unlike FHA loans, there is no ongoing mortgage insurance. Note that VA loans can only be used for your primary residence.
In order to obtain a VA loan, you must meet certain qualifications regarding military service. Both veterans and active duty service members must have served for a certain length of time. Reservists, National Guard members, and surviving spouses may be eligible. In terms of credit scores, the VA doesn’t set a minimum credit score for VA loans, as it encourages the lender to look at your entire credit profile, but individual lenders may have limits as to how low they’ll go.
Ideal for: Those purchasing costly homes
There is a limit to how much can be borrowed for conventional loans. The limit is set by the government by county, and it’s higher in areas with expensive real estate markets, such as California and Hawaii. If you want to buy in a pricey area or you want to purchase a luxury home in an affordable area, you may find that the amount you need to borrow exceeds the limits for a conventional loan. In those cases, you can apply for a jumbo loan, also called a non-conforming loan, which is what it sounds like — a larger mortgage loan that doesn’t conform to Freddie Mac and Fannie Mae’s standards.
Because of that, these loans aren’t backed by the government and are therefore riskier for the lender. This means jumbo loans typically require a heftier down payment and require the borrower to have a larger cash reserve in order to minimize risk for the lender. While borrowing standards are higher, interest rates on jumbo loans are currently very similar to conventional loans. Just like conventional loans, they can be fixed or variable, and they come in a variety of terms.