A Quick Guide to the Different Types of Mortgage Loans
Are you thinking about getting a mortgage to buy your dream home? If yes, you must do some research on the types of mortgage loans available in the market. Each mortgage loan is unique and offers different benefits depending on your needs and local real estate market.
Knowing the type of mortgage that best suits your needs will help you narrow down your search and increase your chances of securing a mortgage. This guide will give you all the information you need about the types of mortgages with their pros and cons. Without further ado, let us dive right in.
Types of Mortgage Interest-Rates
Before exploring the types of mortgages, you must remember that home loans come with two types of interest rates. These are adjustable-rate mortgages (ARMs) and fixed-rate mortgages.
An adjustable-rate mortgage or ARM comes with an interest rate that fluctuates with market conditions over the years. However, the interest rate changes after a few years of getting a mortgage. Suppose you took a 5/1 adjustable-rate mortgage. In this case, your interest rate will not change during the first five years. After the five-year period, your interest rate will adjust once a year.
If you are not sure how long you will be staying in the home you are going to buy, then getting an ARM is a good option for you. This way, you will be able to save a significant amount as the initial fixed interest rate on an ARM is lower than a fixed-rate mortgage.
A fixed-rate mortgage is when you pay a single amount of interest rate throughout your loan’s life cycle. Typically, you can get a fixed-rate home loan for a duration of 15 to 30 years. A fixed-rate mortgage ensures that you have a predictable monthly mortgage repayment.
This is an ideal loan if you are planning to stay in your home for a long time. Furthermore, a fixed-rate mortgage also allows you to stay within your budget as there will be a significant increase in your interest rate in years to come.
Types of Mortgage Loans
There are three major categories of mortgage lenders, each offering a different type of loan for homebuyers.
You can use a conventional loan to buy your primary residence or second home, or even use it for investing in real estate. The interest may be higher, but the overall borrowing cost of a conventional loan is lower than other mortgages. For a traditional loan by Fannie Mae and Freddie Mac, you may be able to pay a down payment as low as 3%. Once you have gained 20% equity in your home, you can request the lender to cancel your private mortgage insurance (PMI). A conventional loan does not come with any government backing and comes in two variants.
Conforming Home Loans
A conforming home loan follows the Federal Housing Finance Agency (FHFA) standards, including debit, credit, and loan size. According to FHFA, for 2022, the limit for conforming loans in most areas is $647,200. If you are considering buying a house in an expensive area, the limit increases to $970,800.
Non-conforming Home Loans
These types of conventional loans do not adhere to FHFA standards. You might be able to secure a traditional non-conforming loan even with a sub-par credit score, or even if you filed for bankruptcy in the past.
To secure a conventional loan, you will require a minimum FICO score of 620 or higher. Additionally, your debt-to-income ratio must be 43% or lower. The lender will also need documentation to verify your income, employment, assets, and the amount of down payment you can afford to pay.
If you are considering buying an expensive home, a jumbo loan is a suitable mortgage. This type of loan does not adhere to FHFA limits as well. If a conventional loan does not cover the cost of the home you wish to buy; a jumbo loan is the best alternative.
The interest rate for a jumbo loan is also very competitive compared to conventional loans. You will have to pay a down payment ranging between 10% and 20%. The FICO credit score requirement to secure a jumbo loan is 700 or higher. Moreover, your debt-to-income (DTI) ratio must be 45% or less.
The lender will ask you to show proof of assets in savings accounts or as cash. Other documentation requirements may vary by each lender.
You can get mortgages that come with government backing from agencies such as:
- U.S. Department of Agriculture (USDA), offering USDA loans
- Federal Housing Administration (FHA), offering FHA loans
- U.S. Department of Veteran Affairs (VA), offering VA loans
If you are on a moderate to low income scale and wish to buy a house in a rural area, a USDA loan is perfect for you. However, to get these mortgage loans, you can only buy a home in a USDA-approved area. If you are on a low income, some USDA loans may exempt you from making any down payment.
However, you may still have to pay other fees, including an upfront mortgage processing fee of 1% of your loan’s total amount. Plus, you will also pay an annual fee. To secure a USDA loan, you need a credit score of 640 or higher. Your household income should be below the USDA’s limit for each eligible area.
As the name suggests, these mortgage loans come with FHA backing. If you are a potential homebuyer but do not have an excellent credit score, or cannot afford to make a large down payment, FHA mortgage loans can help.
To apply for an FHA mortgage loan, you need a credit score of 580 or higher. In this case, your FHA will cover 96.5% of financing while you only have to pay a 3.5% of your loan’s total value as a down payment.
FHA also accepts applications with a credit score as low as 500. However, in this case, you will have to pay a 10% down payment while FHA will come to rest. FHA home loans will require you to pay two PMIs, which will increase your mortgage’s overall cost.
A VA home loan is specially designed for veterans of the US Armed Forces. These mortgage loans offer flexible payment terms and low-interest rates to active duty military personnel and veterans.
A VA loan does not require any mortgage insurance, credit score, or down payment. The closing costs are capped, and a seller can opt to cover the closing costs as of goodwill gesture. A VA loan charges a funding fee, a percentage of your loan’s total amount. You can pay the funding fee at the time of closing or merge it into the costs of your mortgage loan and pay it with your monthly premiums.
If you are a veteran looking to buy a home, a VA loan is an ideal solution. However, it may have higher borrowing costs compared to other loans in the market. The VA-approved lender will ask you to provide documents to prove your employment with the U.S. Armed Forces and your status as a veteran.
Get a Professional Advisor to Create a Financial Plan for You
Once you have decided which of the above-mentioned home mortgage loans are suitable for you, it is time to gather your finances and plan your purchase.
If you are a homebuyer and unsure how to manage your finances to apply for a home mortgage loan, seeking the assistance of a financial advisor may be helpful. Personal Capital gives you an opportunity to collaborate with a financial advisor and build your free personalized plan. Speak to one of the experts today.