A guide to the various mortgage loan options available to borrowers
When shopping for a home loan, it's easy to become confused by the available mortgage terms and products. Learn more about the most common mortgages and determine if you qualify for any of the below-listed specialty mortgages.
Conventional mortgages offer the greatest variety of terms and the most competitive rates and fees.
Federal Housing Administration (FHA) loans can assist borrowers with fewer qualifications in becoming homeowners, but at a steep price.
Those who qualify for U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) loans receive excellent deals.
Jumbo mortgages were also available for expensive properties.
Interest-only mortgages are generally only a good idea in very particular circumstances.
Terms and Rates
Within each mortgage type, the term and interest rate structure can vary.
Mortgage Terms
30-year and 15-year mortgage terms (length) are the most common. Nonetheless, some local credit unions provide terms as brief as two years. The term of your mortgage is the amount of time it will take you to pay it off if you make the monthly minimum payment. A 15-year mortgage amortizes the loan and interest over 180 equal monthly payments. 360 installments comprise a 30-year mortgage.
If your mortgage does not include a prepayment penalty, users can choose to make additional principal payments to pay off your mortgage quicker without refinancing regardless of the loan term you select.
Fixed Rate vs Adjustable Rate Mortgage
A fixed-rate mortgage is one in which the interest rate remains constant throughout the life of the loan. If you close on a 30-year mortgage with a 2.99% interest rate on January 1, 2022, and you never move, refinance, or make additional payments, your interest rate will remain 2.99% when you make your final payment on January 1, 2052. A mortgage calculator can illustrate how different interest rates affect your monthly payment.
In contrast, an adjustable-rate mortgage (ARM) has a rate that fluctuates at predetermined intervals. The most common mortgage ARM terms are 7/1 and 5/1, but any ARM term is technically possible. On a 7/1 ARM, the interest rate is fixed for the first seven years and then is adjusted annually thereafter.
Prior to the subprime mortgage crisis, ARMs were very popular because they offered lower initial payments. However, as rates increased and mortgage payments became unaffordable for thousands of Americans, ARMs caused a wave of foreclosures. Most borrowers should avoid adjustable-rate mortgages unless they intend to pay off their mortgage or refinance before the rate adjusts.
Conventional Mortgages
Conventional mortgages are the most prevalent type of mortgage. In general, they have stricter requirements than government-backed mortgages and are offered by the largest number of lenders.
Who benefits most from conventional mortgages?
Conventional mortgages are ideal for well-qualified borrowers who do not belong to a population eligible for government-backed financing.
Requirements
• Minimum FICO score of 620
• At least a 3% down payment (private mortgage insurance [PMI] will be needed if putting less than 20% down);
• Two or more years of verifiable income;
• A debt-to-income (DTI) ratio of 45% or less;
Government Backed Mortgage Programs
The U.S. government has created numerous unique home-buying programs over the years to promote rural development, revitalize low-income neighborhoods, and assist veterans in becoming homeowners.
USDA Loans
USDA loans were initially created to assist with the provision of mortgages in rural areas devoid of development. They are a unique and extremely attractive option for those who qualify, as they do not require any form of private mortgage insurance and permit borrowers to make no down payment (PMI).
Who are USDA loans most beneficial?
USDA loans are the best option for anyone who qualifies.
Requirements
The property must be located in a USDA-designated rural area, and the borrower's household income must meet eligibility requirements.
• The maximum allowable DTI ratio for borrowers is 41%, with a few exceptions.
• With a few exceptions, the borrower's credit score must be 640 or higher.
FHA Loans
Federal Housing Administration (FHA) loans are loans issued by any FHA-approved lender but insured by the FHA. FHA loans are distinct from HUD loans, which are limited to special situations such as Section 184 loans for Native Americans.
FHA loans are designed to assist low-income borrowers in purchasing a home and have more lenient income, credit score, as well as down payment requirements. In addition to an annual mortgage insurance premium, FHA loans require a one-time mortgage insurance premium equal to 1.75 percent of the loan amount beginning in 2021.
For whom are FHA loans best?
FHA loans are ideal for individuals who are unable to qualify for other mortgages, which are typically much cheaper upfront and over the life of the loan.
Requirements
• Minimum credit score of 500 with 10% down or 580 with 3.5% down
• Minimum down payment of 3.5%
• Verifiable income for two or more years
• DTI ratio less than 43 percent
VA Loans
Loans from the Department of Veterans Affairs (VA) are comparable to FHA loans. They are backed by the VA and issued by VA-approved lenders in accordance with VA requirements. They are similar to USDA loans in that no down payment or mortgage insurance is required. Conventional mortgages offer lower interest rates and fewer requirements. Borrowers must typically be veterans who have served for a certain number of years or under specific conditions.
For whom are VA loans best?
VA loans are the best option for anyone who qualifies.
Requirements
• Borrowers must apply for a Certificate of Eligibility from the VA here.
• No minimum credit score. The lender must deem the borrower's credit risk to be acceptable.
• DTI ratio less than 41 percent
• Minimum down payment of 0%
• Two or more years of verifiable income, with a few exceptions
Other Unique Mortgages
Jumbo Mortgages
Jumbo mortgages are loans for amounts that exceed the Federal Housing Finance Agency's (FHFA) limits for conventional mortgages and are typically issued on luxury properties or in regions with exceptionally high housing costs.
Who should obtain jumbo mortgages?
Jumbo mortgages are ideal for well-qualified purchasers of expensive properties who do not qualify for conventional mortgages and do not have the cash or assets to purchase a home outright. These borrowers are collectively referred to as HENRYs (High Earners, Not Rich Yet).
Requirements
• Credit score of 700 or higher
• Minimum 20% down payment
• Two or more years of verifiable income history
• DTI ratio of less than 43%
Interest-only Mortgages
For a specified period of time, interest-only mortgages require borrowers to pay only the interest portion of their loan. Depending on the terms of the loan, the borrower will be required to pay off the mortgage in a lump sum or with significantly higher payments in the future.
Who benefits most from interest-only mortgages?
Interest-only mortgages are ideal for individuals who have assets that will soon become available, who receive significant periodic bonuses to pay down the principal, or who anticipate a significant increase in income before the principal payment is due.
Requirements
Interest-only mortgages are a niche product with no predetermined requirements. Anticipate having to provide proof of substantial assets and/or future ability to pay when the payments increase.
Should I obtain a loan insured by the Federal Housing Administration (FHA) or a conventional loan?
A conventional loan is less expensive upfront and over the life of the loan than a Federal Housing Administration (FHA) loan, assuming you qualify.
Should I obtain a loan from the United States Department of Veterans Affairs (VA) or a conventional loan?
If you are eligible for a U.S. Department of Veterans Affairs (VA) loan, you can get better rates, lower fees, and less money down, making it a better option than a conventional loan for the majority of borrowers.
How much money I have to put down?
If you have a substantial amount of cash lying around, putting 20% down will save you mortgage insurance premiums as well as make you a more qualified buyer, allowing you to receive the best rates. With current mortgage rates being as low as they are, any cash over the 20% down payment could likely perform better in a retirement savings vehicle such as an individual retirement account (IRA), a 401(k), or a health savings account (HSA) and provide immediate tax savings.
The Bottom Line
Conventional, fixed-rate mortgages are the most popular type of home loan because they offer the lowest rates and fees and are the easiest to obtain. FHA, VA, and USDA loans can help lower-income buyers with average or better credit become homeowners if they do not qualify for a conventional mortgage. Additionally, those who qualify for VA and USDA loans enjoy attractive terms and benefits. Be sure to calculate how a mortgage payment will fit into your overall budget and consider whether purchasing a home is the right decision for you, regardless of the type of loan you choose.
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