Buying a home is an exciting chapter in your life. But once you start thinking about the financial aspects, it can get overwhelming, especially with too many moving parts involved. Fortunately, it doesn’t have to be rocket science. Once you know and understand the different types of mortgage loans, you’ll be able to find one that best fits your needs and goals.
To help you get a head start on your house-hunting, here are six common types of mortgages and what they mean.
6 Types of Mortgages You Need to Know About
1. Conventional Mortgage
A conventional mortgage is a type of home loan not insured by the federal government. This is used when purchasing a primary home, secondary home, or any investment property.
Borrowers with good credit, stable employment, a strong income history, and who have the ability to put down at least a 3% down payment can qualify for this mortgage loan backed by FannieMae or Freddie Mac – two government-sponsored enterprises that buy and sell most mortgages in the U.S.
Most lenders will require you to pay private mortgage insurance (PMI) on conventional loans if you make less than a 20% down payment. You can, however, ask your lender to cancel the PMI once you’ve gained 20% equity of the home’s price. Some lenders offer a low down payment and no PMI on conventional mortgages.
2. Jumbo Mortgage
This is a type of non-conforming conventional mortgage, meaning the home price exceeds federal loan limits. Currently, the maximum confirming loan limit for single-family homes is about $510,000, while the ceiling for certain high-cost areas is around $765,000. Jumbo loan limits can vary by county, are adjusted periodically, and can have fixed or variable interests.
Jumbo mortgages are risky for lenders, so you must show large cash reserves, prove excellent credit, and be able to make a down payment of 10-20% or more. It allows you to borrow more money and enjoy competitive rates.
However, to qualify, you must have a FICO score of at least 660-700 and have a debt-to-income ration of 45%. Thus, jumbo mortgages are better suited for high-income earners who can cover a substantial down payment immediately. They are also for buyers of expensive homes or owners who want to refinance jumbo mortgages.
3. Fixed-Rate Mortgage
A fixed-rate mortgage means the interest rate and monthly principal and interest payments remain the same throughout the life of the loan. This commonly comes in terms of 10 to 30 years, depending on your financial situation and needs.
This type of mortgage is ideal for buyers who plan on owning or staying in the same home for a long time. The consistency and predictability fixed-rate mortgages offer make it a lot easier to set month-on-month budgets. It also provides room to meet other needs.
4. Adjustable-Rate Mortgage (ARM)
ARMs have fluctuating interest rates depending on market conditions and changes in the financial index associated with the loan. Most ARM products have a fixed interest rate for the first few years of the loan term, but after that period, it will change to variable interest.
These loans tend to be risky and unpredictable. It’s best to look for an ARM that offers a rate cap. This will help ensure that you can still handle payment increases up to a certain point.
ARMs allow you to enjoy a lower fixed rate in the first few years of repayment, so they can save you substantial money during this time. However, this type of mortgage is only ideal if you’re comfortable with risk, don’t plan on staying in your home beyond the loan term, or intend to refinance your home before the loan resets.
5. Government-Insured Mortgage
Government-insured mortgages generally come in three kinds of loans: Federal Housing Administration (FHA), Veterans Affairs (VA), and U.S. Department of Agriculture (USDA).
FHA loans make homeownership possible for people who don’t qualify for conventional loans or can’t afford a significant down payment. FHA doesn’t directly lend money, but it guarantees loans by approved lenders. A 500 FICO score is allowed if you put down at least 10% down payment, and 580 to qualify for 3.5%. You will, however, need to pay an upfront an annual mortgage insurance premium (MIP) to protect the lender from borrower default, which can increase the total cost of your mortgage.
VA loans are for members of the U.S. military (both active and veterans) and their families. You can finance 100% of the loan without a down payment. It also doesn’t need a PMI and broker fees, and closing costs are capped. However, it charges a funding fee – a percentage of the loan amount – to offset the cost to taxpayers.
USDA loans help low-income borrowers buy homes in rural areas nationwide. This requires little to no down payment as long as you meet the eligibility rules – such as purchasing a home in a USDA-eligible area and meeting particular income limits.
6. Interest-Only Mortgage
This type of mortgage requires you to pay only the interest charge of your monthly payment for a certain period – usually between five to seven years. After that time, the payment increases as you begin to pay the loan balance or principal.
With interest-only mortgages, repayment time is slow and you won’t get to build equity quickly. But, it's ideal if you know you don’t expect to stay in the house too long or will sell or refinance your house. It's also best if you expect an increasing income or larger savings at a later time (e.g. receiving annual bonuses).
Before choosing a type of mortgage loan, check your credit report to spot and fix errors, work on paying down existing debts, and improve payments – all of which can help you secure a pre-approval letter from a mortgage lender. Be sure to assess your financial situation and current needs, and to research which type of mortgage will help you land your dream home.
Home matters can get confusing and stressful. That’s why you need professionals who’ll be with you every step of the way. At The Brendan King Group, you’ll find experienced realtors ready to guide you with your mortgage queries and more. Contact us today to learn more.