Buying a new home may be one of the most significant purchases you’ll make in your life. You’ll need to explore mortgage options unless you’re buying your house in cash.
The different mortgage loan types are designed to appeal to borrowers’ differing needs. In other words, not all home loans are the same. That’s why it’s essential to research different mortgage products and pick the best one for your financial situation.
Let’s look at the different types of mortgage loans, how to know which type is right for you, and what to do once you decide.
Conventional home loans
A conventional loan is a mortgage loan that’s not backed by the federal government and is based on standard borrower criteria.
The conventional mortgage is a good choice if you have a credit score of at least 620 or higher and a substantial down payment saved. At least 3% of the home’s purchase price is required for a down payment. Anything under 20%, however, will require that the buyer pays for private mortgage insurance (PMI).
Conventional home loans account for 82% of the mortgage market due to their flexible requirements. Specifically, the 30-year fixed-rate conventional mortgage is the most popular choice among homebuyers.
There are two types of conventional home loans.
Conforming home loans
Conforming loans are mortgages under specific dollar amounts, known as conforming loan limits, which are set annually by the Federal Housing Finance Agency.
Conforming loans also meet the underwriting guidelines of Fannie Mae and Freddie Mac, the government-sponsored entities that buy conforming loans.
Non-conforming
A non-conforming loan is a conventional mortgage that exceeds the FHFA conforming loan limits or falls outside of the underwriting guidelines of Fannie Mae and Freddie Mac.
Non-conforming mortgage terms and conditions vary widely from lender to lender, but mortgage rates are typically higher because they carry greater risk for a lender.
Government home loans
Government loans are insured or backed by the U.S. federal government.
Although the U.S. government isn’t a lender, it can insure certain types of loans that meet eligibility requirements for income, loan limits, and geographic areas. Let’s look at a rundown of the types of government mortgage loans.
Federal Housing Administration (FHA) Loans
A Federal Housing Administration (FHA) loan is designed to help low- to moderate-income families attain homeownership. These loans are insured by the government and issued by a bank or FHA-approved lender.
These loans require a lower minimum down payment, making them popular with first-time buyers. Applicants can have a FICO score as low as 500 to qualify for the loan, with a 10% down payment, and as low as 580 to qualify for a 3.5% down payment.
FHA loans do, however, require that all borrowers pay a mortgage insurance premium (MIP).
Use our FHA loan calculator to estimate your FHA loan’s monthly payment and total interest.
Veterans Affairs (VA) Loans
The U.S. Department of Veterans Affairs (VA) insures qualified military service members’ home mortgages. Other qualified service members include active-duty military, veterans, national guard personnel, reservists, and qualifying surviving spouses that require no down payment.
With this mortgage loan type, veteran home buyers can finance 100% of the loan amount without a down payment.
Other benefits of VA loans include:
- Fewer closing costs than other loans
- Competitive interest rates
- No PMI or MIP
A VA mortgage calculator can calculate your monthly mortgage payments with taxes, insurance, and the VA funding fee. The VA funding fee is a one-time payment to support the loan program in lieu of mortgage insurance or down payments.
U.S. Department of Agriculture (USDA) Loans
USDA loans are government-insured loans that can help you buy a home in a suburban or rural area. While these loans require little to no down payment, the home must be in an eligible rural area, and home buyers also need a credit score minimum of 640.
These loans are best for homebuyers in eligible rural areas with not much saved for a down payment and who can’t qualify for a conventional home loan.
Fixed-Rate Mortgages
Fixed-rate mortgages are ideal for homebuyers who intend to stay in their home for many years. With fixed-rate mortgages, you can maintain the same interest rate all through the life of your loan. This means your monthly mortgage payment is consistently the same amount.
Although some lenders allow homebuyers to pick any term from 8 to 30 years, fixed-rate mortgages typically come in terms of 15 years or 30 years.
A 15-year term can help you pay your home off quicker and pay less in interest overall. But your monthly mortgage payment will be higher. That’s why it’s up to you to decide what is more important to you—monthly financial needs or saving money throughout the mortgage.
Adjustable-Rate Mortgages
Adjustable-rate mortgages have more risks than fixed-rate ones, but this is possibly the best type of home loan if you plan to sell the house or refinance the mortgage sometime in the future.
Unlike the stability of fixed-rate loans, adjustable-rate mortgage (ARMs) interest rates fluctuate with market conditions. Many ARM mortgage loan types have a fixed interest rate for a few years (such as ten years) before the loan changes to a variable interest rate for the remainder of the term.
How do I know what type of mortgage is best for me?
Deciding on the best mortgage type for your needs depends on many factors, such as your debt-to-income ratio, credit history, credit score, and overall financial goal. The following are some factors to help you decide the mortgage type best for you.
Affordability
Start by calculating how much you can afford to pay with a mortgage calculator. You can also compare different loan scenarios by using a loan comparison calculator.
Downpayment
Make sure you have some money aside for the down payment. With a too-small down payment and a little downturn in the real estate market, you could have a big loan and a home worth less than you owe.
Loan term
Consider the term you will be most comfortable with. Some lenders even offer varying loan lengths from 10 to 30 years. Suppose you can afford bigger payments of a shorter-length loan. In that case, you will likely see two benefits: a better mortgage rate and a significant reduction in your interest expense over the life of the mortgage.
Interest rate
The interest rate you will pay to borrow the money for your home is another critical to choosing the best mortgage loan. Choose between a fixed rate and adjustable rate mortgage.
Find a reliable mortgage lender
Shopping for at least three lenders to compare mortgage products is advisable. Whatever mortgage loan type you decide to go with, it’s important to check your credit report.
Credit reports usually itemize all your loans, current debts, bill payment history, and other financial information. Get a credit report and find errors, work on paying down debt, and improve any history of late payments before approaching a mortgage lender.
Get pre-approved
Getting pre-approved is essential to buying a home. Pre-approval means your mortgage lender has evaluated and authenticated the submitted credit and paperwork and authorized a particular loan amount.
Pre-approval typically lasts from 60 to 90 days. With a pre-approval letter, you will be able to act when you see a house you like, and sellers will take you more seriously.
Decide on the best mortgage type with AAA Banking.
Choosing the right mortgage loan type is crucial to making an informed decision about buying a home.
At AAA Banking, we are committed to providing information to help you start your home ownership journey. We want to support you as you make the best decision for your family and your financial well-being. Get started today!
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