5 Types of Mortgages Homebuyers Should Know
Most people need a home loan (also known as a mortgage) to finance their home purchase. While several mortgage types exist, buyers may be eligible for more than one. Before buying a dream home, learning the details of each mortgage will help homebuyers understand and evaluate their best options. Keep reading to learn about five types of mortgages, including their requirements.
Government-backed Mortgages: Private Lenders, Federally Insured
Government-backed mortgages are offered by private lenders but are insured by a federal government agency. In most cases, these loans may be used only for a primary home. The agencies that guarantee loans are:
- The Veterans Administration. VA mortgages are for active-duty military or veterans and their families. They generally do not require a down payment and typically have low rates.
- The Federal Housing Administration. FHA mortgages are for borrowers who can only provide a small down payment or have lower credit scores. For example, those with credit scores of at least 580 can borrow with only 3.5 percent down, and those with lower scores may be able to borrow by paying more down. The loans have maximum limits, which change annually and vary by county depending upon the cost of housing in that county. Only approved lenders offer FHA loans.
- The USDA. These loans are for borrowers in rural areas, and qualified buyers may be able to borrow with zero down.
Government-backed loans tend to cost a little more than those that are not federally insured. However, they provide options for those who might have trouble qualifying for a conventional mortgage because of income, credit, or the down payment.
Conventional Loans: Privately Lent and Insured
Conventional loans are any mortgages that a federal agency does not guarantee. Conventional mortgages finance primary homes, vacation homes, or investment properties. The overall cost of borrowing is generally lower than with government-backed loans, but borrowers will have to meet higher credit score rules, typically more than 620. Rules surrounding debt-to-income ratios are stricter.
Adjustable-Rate Mortgages: Government Loans with Changing Rates
Adjustable-rate mortgages (ARMs) are federally backed loans in which the interest rate changes throughout the life of the loan. Typically, the loans have an introductory period, such as five years, during which the interest rate remains stable. After the introductory period, the interest rate will change based upon a specific index or reference rate such as the prime rate or LIBOR rate (London Interbank Offered Rate.) ARMs generally have a cap on how high the rate can go and how much it can change within a short period of time.
ARMs allow borrowers to have a lower monthly payment during the loan's early years but carry the risk that the interest rate and monthly payment will be higher in subsequent years. Depending on the index used, the overall amount of interest paid through the life of the loan may be greater with an ARM than a fixed rate.
Fixed-Rate Loans: Government Loans with Predictable Interest
Conventional or government-backed loans can also be fixed-rate loans. Fixed-rate loans have the same interest rate throughout the life of the loan, usually 15 to 30 years. This type of loan is ideal for people who don't plan to immediately pay off the entire loan.
Jumbo Loans: Conventional Loans Greater Than Federal Limits
Conventional loans may also be jumbo loans. Jumbo loans are mortgages that exceed federal loan limits. These limits vary based upon location. Borrowers in high-cost locations such as Silicon Valley, New York City, or Honolulu often need jumbo loans to finance their homes. Qualification for jumbo loans is stricter since the lender is assuming a higher risk.
Which Mortgage Is Right for You?
Whether investing in real estate or buying a first home, a mortgage is usually necessary. When deciding which type of mortgage is right for you, consider the price of your home, your credit scores, your down payment, and your income relative to your debts. Though getting a mortgage can sometimes be difficult, with so many types of mortgages, most people will find one that works for them.