4 Types of Mortgages: A Complete Guide
What Is a Mortgage? The term mortgage refers to a loan used to purchase or maintain a home, land, or other types of real estate. The borrower agrees to pay the lender over time, typically in a series of regular payments that are divided into principal and interest. The property serves as collateral to secure the loan.
Did you know there are several different types of mortgages? You’ll want to start to review the types of mortgage loans if you’re considering buying a home. Your mortgage selection is going to determine your finances for a long time to come!
First, let’s clear up any confusion about the basics of a mortgage. Simply put, a mortgage is any type of loan that is used to purchase or refinance a house!
If you can pay cash outright for the house, then you can avoid a mortgage. If not, most people use a mortgage to buy a home. There are 4 types of mortgages that we want you to know about!
A reverse mortgage is when your home’s equity is converted into cash. This is only allowed for people who are 62. Reverse mortgage rates vary depending on your situation, so be sure to consult an expert to decide which route is best for you.
A conventional loan is exactly what it sounds like — the classic approach to obtaining a housing loan.
The conventional loan is designed for homebuyers that have good credit scores (minimum 620), a low debt-to-income ratio (45-50%), and a stable income. This type of mortgage loan is not backed by the government.
Your down payment can be as low as 3% with a conventional loan. However, the standard down payment with a conventional loan is 20% of the housing cost. Opt for the 20% down payment to make the most of the conventional loan.
There are two different types of conventional loans you should be familiar with.
A conforming loan means that a certain amount of money is under the maximum limit set by the FHFA (Federal Housing Finance Agency). The amount is determined based on the county where your new home will be located. This can impact the process you need to follow, so be sure to do your homework!
A nonconforming mortgage loan is a large mortgage amount that is above the FHFA limits. The most common nonconforming loan is known as a jumbo loan!
A jumbo loan is likely to be used in higher-cost areas. Affluent buyers with high incomes should explore the jumbo loan option. Be ready to provide documentation to qualify.
2. Government-Backed Mortgages
U.S. government agencies back certain types of mortgage loans. These options help out if you are ineligible for a conventional loan.
Government-backed mortgages require lower down payments and have lower minimum credit score requirements. On the flip side, there are more regulations and eligibility criteria for each type of mortgage.
FHA (Federal Housing Administration) Loans
FHA mortgage loans are great for first time homeowners! The down payment associated with this type of mortgage is only 3.5% down. Review the maximum borrow limit – the FHA sets a value each year based on your area.
VA (Veterans Affairs) Loans
For all active and former U.S. military members, there is no required down payment and low-interest mortgage payments with a VA loan.
The minimum credit score for a VA loan is 580. Beware of closing fees and a one-time funding fee, but know there are ways to negotiate to have this paid for by the seller.
USDA (U.S. Department of Agriculture) Loans
The USDA loan is an attractive option that depends on the location of your new home. You must be moving to an eligible area to qualify.
USDA loans are usually intended for rural areas, and will be available to moderate- to- low-income homebuyers. In certain cases, you may not need a down payment!
3. Fixed-Rate Mortgage
A fixed-rate mortgage will result in a predictable, monthly payment. Fixed-rate mortgages tend to be an agreement over 15, 20, or 30 years.
For this reason, you should plan to be in your house for at least 7 to 10 years when selecting a fixed-rate loan. Look closely at interest rates for your fixed-rate mortgage. You are likely to pay higher interest with this option.
4. Adjustable-Rate Mortgage (ARMs)
The adjustable-rate mortgage is for future homeowners comfortable with uncertainty. ARMs are subject to market conditions and are volatile in comparison to fixed-rate mortgages. If you select an ARM, you should understand the current state of the industry.
Some ARMs will start off with a low, fixed-interest rate. This allows for early savings. If you don’t think you will live in your new home for a long time, this could be the best type of mortgage loan for you!
The type of mortgage you choose will vary based on the your needs as the borrower.
A home is one of the best and also most expensive assets one can own. Choosing the right mortgage loan is very important. A home owner is more likely to be able to stay with their repayment if they choose a home and a mortgage that they can afford. Being realistic about what one can and can’t afford is important. You can always sell and buy a bigger or better home in the future.