April 30, 2024
There are a variety of ways to finance a home and many different terms to choose from. We’ve rounded up your options so that you can make smarter decisions.
There are a variety of ways to finance a home and many different terms to choose from. We’ve rounded up your options so that you can make smarter decisions.
At any given time, different types of home loans may be available with terms that vary widely, depending on the length of the amortization period, conditions in the broader economy, and the individual characteristics and creditworthiness of the borrower. In addition, determining which home loan is right for a specific borrower is a function of determining what’s most important to that borrower — overall cost, monthly payment amount, timeline or a streamlined approval process.
Our guide to mortgage types and terms is designed to provide you with a quick and easy reference so that you can find the loan that checks off all of the boxes on your list. Whether you use it to plan ahead for a future purchase or to choose among several options that your lender has told you about, you’ll find the information you need to make the right decision here.
While there are hundreds of individual loan products available to a wide variety of borrowers from a wide variety of lenders, broadly speaking there are four main categories of home loans. Here you’ll find their main features:
Conventional loans are offered by lenders and are not backed by any government entity. They can be used for a wide variety of purchases, including a primary home, a second home or an investment property.
A conventional loan might be a good option for you if you meet the following criteria:
For conventional loans with lower down payments, PMI, or private mortgage insurance, can be canceled by the lender without refinancing.
There are a variety of government-backed home loans available for different types of borrowers. While the government doesn’t lend the money directly, it helps to insure them so that more buyers can qualify for home ownership. These include:
Among the most popular of the government-backed loans is the FHA loan. These loans are available for borrowers who have a lower credit score and, often, less money for a down payment. Qualifying credit scores are 580 for those with a 3.5 percent down payment or 500 for those with a 10 percent down payment.
FHA loans require the payment of mortgage insurance premiums, which may add significantly to the monthly loan payment. Once the borrower has 20 percent equity in the home, they will need to refinance into a conventional loan in order to stop paying PMI.
One of the drawbacks of government-backed mortgage loans is that the borrower must be the primary resident in the property during the term of the mortgage. However, you may be able to purchase a duplex, triplex, or quad, occupy one of the units and rent out the others, even with an FHA or other government-backed mortgage.
Conforming loans are conventional loans that meet underwriting guidelines set by the Federal Housing Finance Agency or FHFA. These government-sponsored entities buy conforming loans, allowing them to be bundled into investment for later sale. In order to “conform,” loan limits are set for each county in the country, and those that meet the limits are considered conforming.
Non-conforming loans include so-called “jumbo” loans — those that exceed conforming loan limits for their local market. Non-conforming loans exist outside of Fannie Mae and Freddie Mac underwriting guidelines, so their terms vary greatly from one lender to another.
Jumbo loans in particular often:
For borrowers with very little money put aside, there are mortgage options that require no down payment at all. These often have specific requirements for borrower eligibility or location.
VA loans are available for members of the military and their families. They do not require a down payment or private mortgage insurance, there is no minimum credit score to qualify and closing costs are usually capped. There is a funding fee equal to a percentage of the VA loan amount; this can be paid at closing or rolled into the terms of the loan itself.
USDA loans are for moderate to low income borrowers seeking to purchase a home in a rural market. Borrowers must purchase in a USDA-eligible area and must meet defined income limits which can vary depending on the market. While a down payment is not required, USDA loans do have fees, including an upfront fee equal to one percent of the loan amount and an annual fee.
In many markets, for first-time borrowers, and for borrowers in some specific professions, there are down payment assistance options that can defer or eliminate some or all of their required down payment. Grant programs may provide full loan forgiveness while others may defer the down payment until certain criteria are met or offset the down payment through tax credits.
Different down payment assistance programs have different requirements. Talk to your lender about those you may qualify for.
Some mortgages, called fixed-rate mortgages, provide a specific interest rate that is locked in for the life of the loan. Others, called floating rate mortgages, have an adjustable interest rate that “floats” up and down with interest rates prevailing in the mortgage market.
The advantage of a fixed-rate loan is that it provides a predictable, reliable payment, allowing you to budget consistently throughout the term of the mortgage. The advantage of floating-rate loans is that they may, under certain circumstances, provide a lower loan amount of interest rates become more favorable. However, they may also go up in the event that interest rates increase.
A 30-year fixed-rate mortgage is, perhaps, the most popular option for most homebuyers. It offers a longer amortization period for lower monthly payments, with an interest rate that is locked in for the life of the loan.
A 15-year fixed-rate mortgage is popular with borrowers who are willing to pay more each month in exchange for a shorter time period until the loan is paid in full. It is also popular with those who are refinancing into a shorter loan period at a more favorable interest rate, since the lower interest rate may help to offset the higher principal payment.
An adjustable-rate mortgage is a floating loan with a fixed interest rate for a specific period upfront, which is then adjusted periodically. This is often expressed numerically, for example as a 5/1 ARM which has an interest rate that is fixed for the first five years, then adjusted each year thereafter. There are also one, seven, and 10-year ARMs with different terms.
For those who do not plan to keep their mortgage long term or who plan to refinance at some point in the fixed-rate part of their ARM, this may be a good option, especially since the initial rate is often lower than those of others loans.
Interest-only mortgages are just what they sound like – mortgages whose payments are only applied to the interest on the loan. Borrowers must pay down the principal on their own through separate payments. This is a good loan option for those who receive large annual bonuses or who anticipate a significant increase in their income in the years to come.
The best way to find out which home loan is right for you is to talk to your lender along with your trusted real estate agent or broker. Your lender can help you determine which type of loan you qualify for and how much you may be able to borrow. Your real estate agent can then help you determine what type of home and what neighborhood your budget will enable you to afford.
In addition, consider your personality type and your risk tolerance when considering your loan type. For example, if you crave stability and long-term predictability, a 30-year fixed rate mortgage may be the right choice for you. If you are willing to trade longer-term uncertainty for short-term affordability, you may want to consider an ARM or an interest-only mortgage.
Newzip offers the professional guidance you need to navigate the complexities of today’s mortgage and real estate markets. We have the resources and expertise required to ensure that your questions get answered and you make the decisions that are right for you.
