As a prospective home buyer, it’s just as important to research types of mortgages as the neighborhoods you want to live in. Applying for a home loan can be complicated, and deciding which type of mortgage best suits your needs early on will help direct you to the type of home you can afford.
There are a number of loans to choose from when you buy a home, so it’s important to fully understand the advantages and disadvantages of each type before you make a decision. Depending on the type of mortgage you choose, you’ll have different requirements that influence your rate, loan terms and your lender. Selecting the right mortgage for your situation can lower your down payment and decrease the overall interest payment over the life of the loan.
What Is a Mortgage?
There are two components to your mortgage payment—principal and interest. Principal refers to the loan amount. Interest is an additional amount (calculated as a percentage of the principal) that lenders charge you for the privilege of borrowing money that you can repay over time. During your mortgage term, you pay in monthly installments based on an amortization schedule set by your lender.
Conventional loans are what most people imagine when they think of a mortgage loan. This type of loan is not backed by the government, so your home will usually act as collateral in the event that you are unable to pay back your loan.
Within a conventional loan, you have two options: conforming and non-conforming. The differences between them are rather significant, so be sure to read through them carefully before moving forward with a conventional loan. The most important thing to know about them is that conforming loans meet all FHFA requirements whereas nonconforming loans do not.
Conventional loans can be used to buy a primary home, secondary home, or an investment property and you may be able to pay a down payment of as little as 3% through Fannie Mae or Freddie Mac. Once you’ve reached 20% equity, you can even ask your lender to cancel your private mortgage insurance and save a bit on your monthly payments going forward.
Unfortunately, in order to qualify for a conventional loan, you’ll need a credit score of at least 620 even if you’re refinancing. Your debt-to-income (DTI) ratio must also be below 43% and you’ll need to pay for PMI if your down payment is less than 20%.
There are different types of government-backed loans that different people may qualify for. If you’re eligible, these mortgage loans can be a great way to find a low or no down payment loan or avoid paying PMI or MIP.
Here are a few of the government-backed mortgage loans that you may discover you’re eligible for.
FHA loans are backed by the Federal Housing Association and only require a 3.5% down payment. If you meet the eligibility requirements, this type of loan can be great for those with a lower credit score and those who can’t afford the traditional down payment amount of 20% but still want a secure loan that they know they can trust.
VA loans are backed by Veterans Affairs and are available for veterans and active-duty military members. If you or your partner are eligible for a VA loan, it’s almost always recommended that you take one.
VA loans have no down payment requirements, require no PMI or MIP, and have no minimum credit score requirement. There is a funding fee involved, but it can usually be lumped in with the cost of the loan or the closing costs which are usually capped.
For properties that are located in rural or other USDA-eligible areas, you may be able to take out a USDA loan. There are specific income requirements, but some borrowers may be exempt from a down payment. USDA loans do have extra fees and require mortgage insurance, but they can be a great way to buy rural property.
Fixed-rate loans come as two options: 15-year or 30-year. Whether you choose a longer loan term or a shorter loan term, though, the idea behind a fixed-rate loan stays the same.
For the full duration of your loan, the interest rate will remain the same. You won’t have to worry about fluctuating interest costs and your monthly payments will always stay the same, but you’ll usually pay a higher interest rate than you would for an adjustable-rate loan and you’ll end up paying quite a bit in interest overall.
Contrary to a fixed-rate loan, adjustable-rate loans will have fluctuating interest rates over the lifespan of the loan. This can mean that your monthly payments increase for a time before going back down. Over time, you’ll likely end up paying less in interest, but the fluctuating monthly costs could make your loan unaffordable and result in your loan defaulting.
Jumbo loans are common in areas where prices are extremely high, such as in Los Angeles, New York City, and Hawaii. They do not meet FHFA requirements as they are above the set limit, but they do make it possible for you to buy a more expensive property if you need or want to.
For a jumbo loan, you’ll usually need to make a down payment of 10-20%, have a minimum credit score of 700 or more, have a DTI below 45%, and provide a significant amount of assets in the form of either cash or a savings account.
Jumbo loans are good for buying expensive homes, but you’ll need excellent credit and a variety of documentation before you’re approved for one. They aren’t suitable for every home sale, but they can be helpful for those who live in expensive metropolitan areas and want to purchase their own home.
Find Your Perfect Mortgage Loan
Every lender and loan will be different, so make sure to take your time when looking around. With enough research and the help of a professional, you’ll be able to find the perfect mortgage loan in no time for your new home. While you search, though, it’s important to remember to stick to your predetermined budget and only search for loans through approved lenders to avoid scams or exorbitant fees.