Types of Mortgages
Before you start looking for the perfect home that meets all of your needs, you should first take some time to identify the type of mortgage you'd like to apply for. There are numerous mortgage types that you can select from, each of which has its own unique advantages. The mortgage that best suits you depends on many different factors, which include everything from your credit score to the down payment you can make. This guide offers a comprehensive look into the numerous types of mortgages available to you.
Why Are There Different Types of Mortgages?
Not everyone is in the perfect position to purchase a home. While conventional mortgages can offer low interest rates, the down payment requirements are relatively high. If you don't have enough savings, you may not be able to meet these requirements. It's also common for potential buyers to find that their credit score isn't high enough to be approved for a conventional mortgage.
The reason that there are numerous types of mortgages is to make sure that prospective buyers have a variety of options to select from. If you're unable to qualify for one mortgage, you might be able to qualify for another. Because of how important it is that you choose the right mortgage, make sure that you weigh the pros and cons of each before making your final decision.
Factors to Consider When Selecting a Type of Mortgage
Since many types of mortgages are at your disposal, there are several factors that you should keep in mind as you search for the ideal mortgage. The primary factors include credit score requirements, down payment requirements, and availability of income/assets.
Down Payment Requirements
Different types of mortgages have different down payment requirements. If you apply for a conventional loan, the down payment requirements are entirely up to each individual lender. While some lenders set their requirement at 3.5% of the sale price, other lenders require a down payment of 5%.
In the event that you apply for an FHA loan, your down payment must be at least 3.5% if you have a credit score of 580 or higher. A credit score of 500-579 will require a down payment of at least 10% to reduce the lender's risk. If you're eligible for a VA loan, you can qualify for this type of loan even if you're unable to make a down payment of any amount. The same is true with a USDA loan.
Keep in mind that the down payment you make will play a part in the interest rate you receive from your lender. A higher down payment typically means that the interest rate you pay will be lower. If you're applying for a conventional loan and would like to avoid paying for private mortgage insurance, you'll need to make a down payment of at least 20%. If your down payment is lower than this, you'll need to obtain private mortgage insurance before receiving the loan.
Income and Assets
Mortgage lenders always take a look at the amount of assets and income that borrowers have before determining how much they can afford. Regardless of the type of mortgage you obtain, your lender will want to be confident that you have the assets and income needed to make the monthly mortgage payment. This payment is comprised of taxes and interest, the principal amount, utilities, and mortgage insurance.
If you live in an area with an HOA, your HOA fees will be part of your monthly mortgage payment. The income and asset requirements that lenders have will invariably be higher when it comes to conventional or jumbo loans. Government-backed loans like FHA and USDA loans usually come with lower income and asset requirements, which may make it easier for you to buy a home.
Likely the most important aspect of obtaining a mortgage is your credit score, which will dictate which loans you can apply for and what your terms will be. If you have a credit score that's above 750, there's a good chance that you will qualify for any type of mortgage and will likely receive a low interest rate.
High credit scores show lenders that you are able to make consistent and on-time payments, which helps to improve a lender's confidence in giving you a loan. For a conventional loan, you will need a credit score of at least 620. However, lenders prefer credit scores that are higher than 740. At this score, it's possible that the minimum down payment requirement will be reduced.
If you don't have a great credit score at the moment, there are numerous steps you can take to improve your score. Along with making consistent payments every month, it's also important that you pay off some of your debt, which will automatically bolster your credit score and improve your standing among lenders.
Types of Home Loans
There are essentially seven different types of home loans that you can apply for, which include everything from conventional loans to VA loans. All of these mortgages are separated into conforming loans and non-conforming loans, which you should be aware of before deciding which mortgage is right for you.
Conforming vs. Non-conforming
When you hear that a loan is conforming or non-conforming, the difference between these two terms is that conforming loans are purchased by real estate investment companies while non-conforming loans are kept and managed by the lender. The types of conforming mortgages available to you include conventional mortgages, fixed-rated mortgages, and adjustable-rate mortgages.
Conforming loans are purchased by Freddie Mac or Fannie Mae, both of which are real estate investment companies. All conforming loans have stringent guidelines on who can be approved for a loan. Since lenders sell these mortgages to real estate investment companies, they are less risky for the lender, which means that your interest rates could be low. However, you'll typically need a credit score of 620 or higher to qualify for a conforming loan.
As for non-conforming loans, these mortgages don't meet the conforming standards that have been set, which isn't necessarily bad for you as the borrower. The guidelines for these mortgages are less stringent, which indicates that you'll be able to receive a mortgage even if you have a low credit score and don't make a sizable down payment. It's even possible to obtain a non-conforming loan if you have a bankruptcy on your credit report. Most non-conforming loans are backed directly by the government.
What Is a Conventional Mortgage?
The most common mortgage type is the conventional mortgage, which allows borrowers to obtain a loan with a down payment of as little as 3%. As mentioned previously, the minimum credit score that's accepted for this mortgage is 620. If you make a down payment of 20% or higher, you can skip buying private mortgage insurance.
Keep in mind that the rates associated with private mortgage insurance are usually lower for conventional loans than they are for FHA loans. If you have a great credit score as well as the means of making a high down payment, a conventional mortgage may be the perfect solution for you. Otherwise, you may be unable to qualify for this mortgage type because of the strict requirements.
Fixed Rate vs. Adjustable Rate
It's possible for you to obtain a fixed-rate mortgages or adjustable-rate mortgage, both of which are considered to be conforming loans. Fixed-rate mortgages will have the same interest rate throughout the entire loan term, which means that you will have stable and consistent monthly mortgage payments.
If you believe that you're going to live in the home you're about to buy for many years, a fixed-rate mortgage may be right for you. If you find that interest rates in your specific area are currently high, you might want to avoid a fixed-rate mortgage since it essentially locks in a high interest rate throughout the duration of the loan.
Adjustable-rate mortgages are considered by most buyers to be riskier than fixed-rate mortgages since interest rates can either increase or decrease after a set period of time. These mortgages come with 30-year terms alongside an introductory period when your interest rate remains fixed. This period can range from 5-10 years.
After the introductory period is over, your interest rate will likely adjust every six months depending on market shifts. The fixed rate that you pay at the beginning is typically lower than what you would pay for a fixed-rate mortgage with a 30-year term.
This type of mortgage is risky because your interest rate could increase substantially in a short period of time. However, lenders are required to place caps on how much your interest rates can rise in a given year, which provides you with some level of protection. This type of loan is advantageous because of the initial low interest rates as well as the possibility that your interest rates will decrease after the introductory period.
What Are Government-Backed Loans?
When you hear that a loan is a government-backed loan, this means that a government agency insures the loan. There are three types of government-backed loans, which include FHA loans, USDA loans, and VA loans. Each loan differs considerably from the others and only applies to certain individuals.
The Federal Housing Administration backs all FHA loans. These loans are designed specifically to help more people qualify to be homeowners. You can buy a home with an FHA loan as long as you have a credit score of at least 580, which is much lower than the score requirement in a conventional loan. Your down payment must be at least 3.5% of the home price. While it's possible to obtain an FHA loan with a credit score of 500-579, your down payment will need to be 10% or higher to qualify.
The U.S. Department of Agriculture insures these loans. Along with meeting certain income requirements, you must purchase a home that's located in a rural or suburban area if you want to qualify for a USDA loan. It's possible to obtain a USDA mortgage without making a down payment. Low-income borrowers may even qualify for loans with interest rates as low as 1%.
The Department of Veterans Affairs insures VA loans, which means that these loans are only available to people who served in the National Guard or Armed Forces. A widow or spouse may also be able to qualify for this loan. VA loans can be highly beneficial because they come with extremely low interest rates and don't require a down payment.
What Is a Jumbo Loan?
A jumbo mortgage is similar to a conventional mortgage but is considered to be a non-conforming loan. If you want to purchase a premium and high-value property, you may need to obtain a jumbo loan. These loans are particularly common in cities with a high cost-of-living, the primary of which include New York City, Los Angeles, and San Francisco. With a jumbo loan, you can purchase a home for as much as $2.5 million.
Conforming loans only allow borrowers to receive around $550,000 or less in a single mortgage. While the interest rates for jumbo loans are similar to the ones for conventional mortgages, it's more difficult to qualify for this type of loan. Along with a high credit score, you must have a low debt-to-income ratio. Your down payment will also need to be at least 10% to qualify.
While there are many different types of mortgages that you can apply for, most types are unique, which means that it shouldn't be too difficult to determine which mortgage is right for you by assessing your situation. If you have a high credit score, a conventional mortgage or jumbo mortgage might be right for you. In the event that you've served in the military, a VA loan may be the perfect option for you and your family. As long as you compare the features of each mortgage early on in the process, you should be able to make an informed decision.