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.
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 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
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 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 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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