While choosing a mortgage can be exciting, it can also feel quite stressful. There are many options, and it can feel like there’s a lot a stake every time you make a decision. There are a lot of different types of mortgages, so how will you know which one is right for you? Not to worry. Here we will go through the main types of mortgages.
Conventional mortgage or FHA loan
One of the first choices you’ll make about your mortgage is whether you want a conventional loan or an FHA loan.
What is a conventional loan?
In the most basic terms, a conventional loan is one that is not backed by a government agency like the FHA or VA. This type of mortgage is guaranteed by a private lender, or Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). With a conventional mortgage, you’ll make a 20% down payment or pay private mortgage insurance (PMI) premiums until you own at least 20% equity in the home.
Generally, a conventional mortgage is more suitable for borrowers who have a more secure financial standing and are able to make larger down payments.
Conventional loan requirements
- Minimum FICO score of 620 for most lenders
- Minimum FICO score of 740 to access the lowest interest rates
- Home can be a primary residence, second home, or investment property
- 20% down payment or 3% to 10% down payment + PMI premium payments
- Proof of employment and steady income
- Maximum debt-to-income ratio of 45% (some lenders allow 50% with excellent credit)
- Term length of 10 to 30 years
What is a FHA loan?
If this is your first time buying a home or if you haven’t had a mortgage for the past three years, you may qualify for an FHA loan. An FHA loan is one insured by the Federal Housing Administration (FHA) and is typically for newer homebuyers or possibly those with lower financial standing.
Homebuyers who don’t have enough money to make the down payment may find that an FHA loan is a better option.
- Minimum FICO score of 580 + 3.5% down payment
- Minimum FICO score of 500 + 10% down payment
- Home must be the primary residence of the borrower
- Proof of employment and steady income
- Maximum debt-to-income ratio of 43%
- Term length of 15 or 30 years
Fixed rate mortgage or adjustable rate mortgage (ARM)
The type of interest you pay on your mortgage could have a significant impact on your overall financial wellbeing. That’s why it is important to consider whether you should get a fixed rate mortgage or an adjustable rate mortgage.
What is a fixed rate mortgage?
A fixed rate mortgage loan’s interest rate doesn’t change during the entire term of the loan. This means the monthly payment also stays the same throughout the term of the loan. Because the rates are not changing, the borrower will pay both a portion of the principal and interest in each payment. This is helpful for financial planning.
A fixed rate mortgage is generally recommended for first-time home buyers and those who are expecting to stay in the home for many years.
What is an adjustable rate mortgage?
An adjustable rate mortgage is essentially a loan whose interest rate changes at some point suring the loan term. For example, you might have a fixed rate for the first three years (known as a 3/1 ARM) or the first five years (known as a 5/1 ARM). One benefit of an ARM is that the interest rates during the initial fixed period may be lower than other types of loans. It is common that the loan may have an interest rate cap limiting how high the rate can go.
This type of mortgage is generally recommended for homeowners who aren’t going to spend more than a few years in the home or who plan to refinance within the first years of living in the house.
Special government-backed loan programs
In the United States there are also certain property or home-buying loan programs for various sectors of the population. The two big examples of this are VA and USDA loans.
What are VA loans?
The U.S. Department of Veterans Affairs (VA) offers special home loans to military service members and certain family members. Borrowers who qualify for a VA loan don’t have to make a down payment with this type of mortgage. As for financial standing, it’s much easier to qualify for a VA loan than it is to get an FHA or traditional loan. There aren’t any hard-and-fast rules about credit requirements. The debt-to-income ratio varies according to the lender but is generally more relaxed than with other types of loans.
What are USDA loans?
The United States Department of Agriculture (USDA) has a special loan program offering low or no down payment mortgages for low-income borrowers who want to purchase a home in designated suburban and rural areas. To qualify for this type of mortgage the household income must not exceed 115% of the adjusted area median income (AMI), which varies by county. You must also be a US citizen and show proof of income. Just like with other mortgages, your financial standing will be assessed, however, the criteria for qualifying will be more lax.
How to choose the right loan for you
Now that you know a little bit more about the types of mortgages out there, you’ll probably want to get started on choosing the right one. With some research, thought, and preparation you will be well on your way to purchasing that home or property you’ve always dreamed of.
Gather financial information and paperwork
No matter what type of mortgage you choose, you will need to provide information about your financial standing, so it is a good idea to start gathering that information and paperwork now. You’ll need information like your credit score, bank statements, pay stubs, tax returns, and more. Additionally, a lot of this information will help you determine what type of mortgage you might want or possibly qualify for. Lucky for you, online loan aggregators like Rocket Mortgage have streamlined this part of the process by allowing you to digitally connect your financial information and quickly see a number of loan offers you might be eligible for.
Shop around for the best mortgage offer
One of the best tips for choosing the right mortgage is to shop around and compare options. Be sure to look at things like APR (annual percentage rate). This is the summary of the total cost of borrowing and includes the mortgage broker fees, points, interest rate, and any other costs of getting the loan. Sites like Credible allow you to quickly compare a variety of mortgage rates and offers from multiple lenders in minutes.
No matter what, with some research, patience, and determination, you will find the right mortgage to suit your needs. Getting a mortgage is a big deal and for many people it represents the biggest purchase they’ll make during their lifetime. Shop around until you find a lender with great terms that you feel comfortable working closely with throughout the process. Closing on a home loan could take weeks or even a couple of months, but with a little patience, you’ll soon be walking through the front door of your new home.