Homebuyers: 5 Types of Mortgage Loans

The process of buying a home involves more than just choosing the right house. There’re different and several types of mortgage loans for homebuyers. In this article we’ll explain each type and analyze its differences.

Conventional Loan

A conventional loan is a mortgage that’s not insured by the federal government. Also, there’re two types of conventional loans: we have conforming and non-conforming loans.

A conforming loan is when the loan amount falls within maximum limits set by the Federal Housing Finance Agency. And a non-conforming loan is a type of mortgage loan that don’t meet the guidelines set by the FHFA. For example, a jumbo loan is the most common type of non-conforming loan. Jumbo loans represent large mortgages above the FHFA limits for different counties.

Pros of conventional mortgage

  • Private mortgage insurance (PMI) can be canceled once you’ve reached 20% equity
  • Closing costs may be lower than other types of loans
  • Can be used to purchase a primary home, second home or investment property

Cons of conventional mortgages

  • Minimum FICO score of 620 or higher
  • Higher down payment than government loans
  • Low debt-to-income (DTI) ratio, usually of no more than 45% to 50%
  • Generally, you’ll have to pay PMI if your down payment is less than 20%

Jumbo loan

Jumbo loans are conventional types of mortgages. However, these have non-conforming loan limits. Being a non-conforming loan means that the home price exceeds federal loan limits. In 2021, the maximum conforming loan limit for single-family homes in most of the U.S. is $548,250. Yet, in certain high-cost areas, the limit is $822,375.

Pros of jumbo mortgages

  • Can borrow more money to buy a home in a high-cost area
  • Interest rates tend to be competitive with other conventional loans

Cons of jumbo mortgages

  • Down payment of 10% to 20% is required
  • Need to have a FICO score of 700 or higher. However, some lenders accept a minimum score of 660
  • Can’t have a debt-to-income (DTI) ratio above 45%
  • Must demonstrate you have significant assets (generally 10% of the loan amount) in savings accounts or cash

Government-backed loans

The U.S. government is involved in helping more people become homeowners. There are three government agencies that back mortgages: the Federal Housing Administration (FHA loans), the U.S. Department of Agriculture (USDA loans) and the U.S. Department of Veterans Affairs (VA loans).

  • FHA loans: these types of mortgage loans help make homeownership possible for those who don’t have a large down payment saved up or don’t have a very good credit score. Borrowers need a minimum FICO score of 580 to get the FHA maximum of 96.5% financing with a 3.5 percent down payment. Moreover, if you put at least 10% down, lenders will accept a credit score of 500.
  • USDA loans. These type of loans help low-income borrowers buy a home in rural areas. In order to qualify, you must buy a home in a USDA-eligible area and meet certain income limits. Some USDA loans don’t require a down payment for eligible borrowers with low incomes.
  • VA loans. Lastly, these loans provide flexible, low-interest mortgages for members of the U.S. military, including active duty, veterans and their families. VA loans don’t require a PMI or down payment. In addition, closing costs are generally capped and may be paid by the seller.

Pros of government-backed loans

  • Help you buy a home when you don’t qualify for a conventional loan
  • Credit requirements more relaxed
  • Don’t need a large down payment
  • Available for first-time buyers and repeat buyers

Cons of government-backed loans

  • In some cases, PMI can’t be canceled in FHA and USDA loans
  • Overall, may have higher borrowing costs
  • Expect to provide more documentation to prove eligibility

Fixed-rate mortgage

Fixed-rate mortgages keep the same interest rate throughout the life of your loan. This means that your monthly mortgage payment will be the same over the term of the loan. A 30-year fixed-rate is the most common type of fixed mortgages. Although you may decide for a 15-year or 20-year mortgage term instead.

Pros of fixed-rate mortgages

  • Monthly payments stay the same over the life of the loan
  • Predictable monthly payments, making budgeting easier

Cons of fixed-rate mortgages

  • With a longer-term loan, you’ll need to pay more interest
  • Takes longer to build equity in your property
  • Rates may be higher than rates on adjustable-rate mortgages

Adjustable-rate mortgage

Adjustable-rate mortgages (ARM’s) have fluctuating interest rates. These rates can go up or down, following market conditions. Many ARM loans have a fixed interest rate for a few years. Then, the loan changes to a variable interest rate for the remainder of the term.

Pros of adjustable-rate mortgages

  • You’ll have a lower fixed rate in the first few years of homeownership
  • Can save money in interest payments

Cons of adjustable-rate mortgages

  • An ARM could become much more expensive, resulting in a loan default
  • You’d need to refinance to a new loan to lock in a fixed rate

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