In a world where very few homebuyers can afford to buy a house directly, banks and other financial institutions have developed many different types of mortgages. If you, too, are on the lookout for a mortgage, it’s good to know all your options. It will help you make an informed decision that will make repaying your loan easier in the long run.
Before you contact a mortgage agent, it can be useful to orient yourself and understand what are the most popular types of loans out there and why.
Fixed Rate Mortgages
Conventional mortgages are provided by private lenders and are not secured by government entities or government-sponsored enterprises like Fannie Mae or Freddie Mac.
The most popular type of conventional home loans, fixed rate mortgages come with an interest rate that stays the same during the entire duration of the mortgage. Lenders that provide fixed rate loans include private lenders such as banks as well as government-sponsored mortgage corporations and associations like Freddie Mac and Fannie Mae.
Because fixed-rate mortgages are not secured by the government, so lenders tend to have stricter requirements. To secure a conventional mortgage, you need to have at least an average credit score, and preferably a good one, though there are exceptions. The better your score, the more options you’ll have. A lower score generally translates to a higher interest rate.
Fixed rate mortgages generally come with a 15, 20, or 30-year term. Because they are considered more secure than adjustable rate mortgages, they tend to be a little harder to obtain. Nevertheless, they are popular among all types of homebuyers.
Pro tip: Working toward improving your credit score to secure a fixed rate mortgage remains a good investment considering the stability and security of this type of loan.
Adjustable Rate Mortgages
Adjustable rate mortgages (ARMs) come with a variable interest rate that resets several months or years into the loan. The rate can then go up or down depending on market conditions, but you’re protected by rate caps and other control features.
With standard rates lower for adjustable rate loans than fixed ones, ARMs continue to be a popular option for homeowners who want lower payments during the first term of the loan.
In 2023, around 17% of mortgage loan applications in the US were for ARMs. Somewhat looser credit requirements compared to fixed rate loans and accessible introductory rates further add to the appeal of these mortgages.
To secure an ARM, you need to submit an official mortgage application and provide financial proof. In addition to a good credit score and a good debt-to-income ratio, being able to make a large down payment will increase your chances of getting a good ARM.
Federal Housing Administration (FHA) Mortgages
Tracing their history to the Great Depression, FHA loans are meant to help first-time homebuyers with a low income or poor credit to finance a home. Unlike other types of mortgage, FHA loans don’t require a high credit score or a big down payment.
To qualify for an FHA loan, you need a rating of at least 580. A down payment of 3.5% of the value of the mortgage is usually enough. To boot, lenders may pay the closing fees for you.
On the other hand, FHA loans come with higher interest rates than other mortgages.
FHA loans are insured by the government. That’s why they are less risky for lenders than most other types of loans, hence the perks they can bring you.
Rural Development Mortgages
Rural development mortgages are guaranteed by the Department of Agriculture (USDA). You become eligible by buying a home in a rural area or in a suburban area. USDA mortgages don’t require a down payment and have looser requirements than conventional house loans.
Borrowers who don’t qualify for a conventional mortgage may still obtain a rural development mortgage. USDA mortgages include direct loans provided by the Department of Agriculture for very low-income applicants.
To qualify for a rural development mortgage, you need to prove you have a dependable income and an acceptable credit history. USDA loans are also open to borrowers with a non-traditional credit history.
Veterans Administration Mortgages
Created for army veterans and members of the National Guard, VA mortgage loans can finance up to 100% of a home purchase. These primary residence loans are provided by private lenders but backed in part by the Department of Veterans Affairs.
Entitlements guarantee 25% of the total mortgage up to $36,000 in case of default. Bonus entitlements are also available based on Federal Housing Finance Agency loan limits, which can reach up to $726,525.
Important eligibility requirements include 90 days of active service during wartime or 181 days of active service during peacetime and being an active member of the Reserves or National Guard for at least 6 years.
Note that widows or widowers of a veteran may also qualify for this loan.
Jumbo Mortgages
Jumbo mortgages are big loans meant to finance properties with a hefty price tag. But don’t think of them as luxury-property loans only.
They can also be useful for financing a property in a very competitive real estate market. Jumbo mortgages exceed $484,350, the conforming mortgage limit for a single-family home in many states according to funding criteria set by Fannie Mae and Freddie Mac. In high-cost areas, they may exceed $726,525. Some jumbo mortgages are interest-only and come with a big balloon payment.
Jumbo loans are not backed by federal agencies and come with strict credit requirements. Jumbo mortgages are not popular in all areas, but for borrowers who want to finance an expensive property, they can be a better choice than conventional loans.
Finding the Right Mortgage for You
These are only some of the most popular home loans available now. Other subtypes of mortgages include rent-to-own agreements, super jumbo loans, and subprime loans. These are not as widely used and can be riskier, but they remain an option for some borrowers.
In the end, when looking for a mortgage, it’s crucial to have on your side a broker who can fully explain every loan type, underlying the pros and cons of each.
