There are several types of mortgage loans, including conventional mortgages, fixed-rate mortgages, adjustable-rate mortgages, FHA loans, VA loans, USDA loans, jumbo loans, 2nd mortgages, and one or more of them could be the right fit for you. A mortgage is a multi-year commitment that involves a significant amount of money, so take your time and review the following to get started.
A conventional mortgage is a mortgage offered by a private lender that is not secured by a government entity. Borrowers can apply for a conventional mortgage at their local bank, credit union, or mortgage company. They are also available online. Conventional mortgages typically have a fixed rate of interest and require a down payment of at least 3% of the loan.
Most, but not all, conventional mortgages are also classified as “conforming mortgages.” This is a standard set by Fannie Mae and Freddie Mac, both of which are federally backed home mortgage companies created by the United States Congress. Their funding criteria include a dollar limit on conventional mortgages set by the Federal Housing Finance Agency.
Fixed-rate mortgages are exactly what they sound like – the interest rate is fixed for the entire life of the loan. This differs from an adjustable-rate mortgage where the interest rate changes based on market conditions. The terms of a fixed-rate mortgage range anywhere from ten to thirty years. This is the most common type of mortgage in the US right now.
Choosing a shorter term on a fixed-rate mortgage will result in a lower overall price to buy the property. Payments are amortized, which means borrowers pay more interest early in the life of the loan. As time goes by, the percentage of monthly payments that goes towards the principal increases, giving the borrower more equity in the property.
Adjustable-rate mortgages (ARMs) have an initial interest rate that adjusts after a certain period of time. This can be suitable for new homeowners with limited resources, but it is important to understand that monthly payments may go up when the interest rate adjusts. This can happen once a year, monthly, or in other increments according to the loan agreement.
ARMs, which are also known as “variable-rate mortgages,” typically set their interest rates based on an index that includes the “prime rate” used by banks. The variable interest rate will usually be set as a percentage above or below whatever the prime rate is on the date of adjustment. This makes adjustable-rate mortgages somewhat unpredictable.
The Federal Housing Authority (FHA) is not a lender, but they can guarantee a loan from a traditional lender. They also require that you purchase mortgage insurance through them. This minimizes risk for the lender since the FHA is guaranteeing repayment if the borrower defaults on the loan. The FHA also has a lower minimum credit score requirement (500+).
A 3.5% down payment is required for borrowers with a credit score over 580. 10% is required if your score falls between 500 and 580. The mortgage insurance premium is 1.75% upfront and 0.45% to 1.05% annually. Loan terms are either fifteen or thirty years. Most lenders encourage new home buyers to take the mortgage loan steps required to qualify for FHA loans.
Like FHA loans, VA loans are not offered by a government entity. The Veteran’s Administration sets the standards and dictates the terms of the loan. A private lender will provide the funds. VA loans are available for active military, veterans, and surviving spouses. Lenders also have their criteria, but approval for a VA loan is easier than conventional loan approval.
Two of the more attractive features of a VA loan are that down payments and private mortgage insurance (PMI) are not required. Closing costs are also smaller and prepayment penalties for buyers who want to pay off the loan early are prohibited. For lenders, VA loans are guaranteed against default by the Government National Mortgage Association (GNMA).
Guaranteed by the United States Department of Agriculture, a USDA loan is for homebuyers who live in rural areas with a population of 35,000 or less. There are two types of USDA loans: Guaranteed and Direct. The former guarantees at least 90% of the loan will be repaid to the lender. USDA direct loans come directly from the USDA.
Direct USDA loans are offered in cases where there are issues with safety and sanitation. Guaranteed USDA loans require no assets, a debt-to-income ratio of up to 41%, and no minimum credit score. These loans are designed for those with lower incomes living in rural and often economically depressed parts of the country.
Larger property purchases that exceed the limits set by the Federal Housing Finance Agency require what is known as a “Jumbo Loan.” These mortgages can range from several hundred thousand to millions of dollars. They are not guaranteed or securitized by Fannie Mae or Freddie Mac, so the credit requirements from lenders are more rigid.
Jumbo loans are typically seen with luxury properties or more expensive homes in competitive real estate markets. Approval will require a credit score of 700 or better and a debt-to-income ratio of under 36%. Interest rates are comparable with conventional mortgages. The minimum down payment required is usually 10% to 15%, down from 30% a few years ago.
This is primarily a financial vehicle to secure more cash on hand. A second mortgage is an additional loan taken out on a property where a primary mortgage already exists. These are also known as “home equity loans” because the second mortgage is typically a loan for the percentage of the property that has already been paid off.
The mortgage loan steps required for the second mortgage are identical to what you would go through taking out a first mortgage. The approval also means having an additional lien placed on your property. This step is usually taken when homeowners want to make improvements or have encountered a life situation that requires additional capital.