It’s very likely that your mortgage loan will be the largest loan you have during your lifetime. Mortgages are not a one size fits all approach, there are many different types of options you can choose from – all having their own unique qualities. To make the best decision, you first must understand the different types of loans, and then, it’s easier to decide which loan is best suited for you. We’ll address the various options below.
There is some foundational terminology worth reviewing that will set the stage to properly understand all the different types of loans. These terms include:
A conventional loan is a mortgage loan that is not backed by any government agency. Conventional loans are issued through private lenders, such as a bank or credit union. Generally speaking, a borrower will have to meet greater requirements to obtain a conventional loan, such as a larger down payment and higher credit score. The higher your credit score, the more preferential your interest rate will be, which can save you a lot of money over the life of your loan.
A conforming mortgage is a loan that conforms with, or complies with, the financing limits and requirements established by the Federal Housing Finance Agency. There are various underwriting requirements that must be met, such as; a minimum credit score, a limit on the loan amount, various debt ratios and even a loan-to-value ratio. For those with a great credit score, a conforming mortgage may be of interest to you due to the low interest rates these loans come with.
A non-conforming mortgage is a loan that doesn’t meet the Fannie Mae’s or Freddie Mac’s standards. This doesn’t mean they are bad loans for the borrower. Rather, they are just harder loans for the mortgage company to resell because they do not meet the standards established by Fannie Mae or Freddie Mac, such as the ratios or limits established in a conforming loan.
Government Insured Mortgages
A government insured mortgage is when the government insures/guarantees a mortgage with the private mortgage lender. This means the mortgage lender is insured against any risk of the borrower defaulting on the loan. If the borrower does in fact default on the loan, the government will step in and pay the mortgage lender. Therefore private lenders are more inclined to issue loans that are backed by the government, as they are insured against any risk of financial loss.
Government insured mortgages make owning a home more reachable and realistic for millions of Americans. There are 3 types of government issued mortgages, which we’ll explain below.
A mortgage interest rate is the rate or ‘fee’ a lender charges you for borrowing their money. When you pay back your mortgage, you must pay back the loan amount, also known as the principal balance, and the interest rate. The interest rate fee is paid throughout the duration of the loan, and is controlled by various economic and government conditions.
Mortgage insurance is an insurance policy that pays the lender for any loss due to the borrower defaulting on the loan. You can have either a private or public mortgage insurance policy depending on the type of loan and insurer you choose. It’s important to note, mortgage insurance does not protect you, the borrower. This is something the borrower pays that insures the lender. If you default on the loan, the lender still gets paid, but you can still lose your home.
Different Home Loan Options
Now with that foundational overview, let’s review the different home loan options.
Fixed-rate loans are the most popular. A fixed-rate loan has an interest rate that does not change throughout the entire life on the loan. The interest rate remains fixed, which provides a huge benefit from a budgeting perspective. It’s also common to see fixed-rate loans apply to the various other types of borrowing, such as; student loans, personal loans, and even auto loans. If a borrower wished to go with a 30-year fixed-rate loan, the lender would require the borrower to pay the loan back over the next 30 years, and no matter what happens to the political or economic conditions in that timeframe, the interest rate will remain flat.
Adjustable-Rate Mortgages (ARM)
Also known as a variable-rate mortgage, an adjustable-rate mortgage (ARM) has an interest rate that can adjust throughout the duration of the loan. The interest rate you are charged is applied to the outstanding loan balance, and varies throughout the life of the loan. For a specific period of time, the interest rate will not change. However, once that time has elapsed, the interest rate will reset periodically. This can be a benefit if you happen to be financing a loan when interest rates are high. But if the rate is at historically low levels, one can only suspect each time the rate adjusts, it will result in a greater monthly interest expense.
A jumbo loan is used to finance properties that exceed the criteria and limits of the FHFA. The properties purchased with these loans are expensive, and as a result, the borrower must meet strict criteria to get approved for these loans. This criteria includes having a phenomenal credit score, and a low debt-to-income ratio. An example of a jumbo loan would be if someone was buying a home that costs $800,000. This would be above and beyond the limits of FHFA, and a jumbo loan would be required to finance this purchase.
These loans are insured by the Federal Housing Administration (FHA) and make the goal of homeowners more reachable for millions of Americans. The minimum credit score for an FHA loan is 580, and you can finance 96.5% of the loan value. FHA loans are a common option for those just starting out, or for those that are working to repair their credit and financial situation. FHA loans do come with mortgage insurance, which again, protects the lender not the homeowner.
If you’re bouncing back from a challenging financial time, or purchasing your first home, consider using an FHA mortgage. The credit score requirements are on the low end, and you don’t need to have a ton of cash saved up to meet the down payment requirement.
A VA loan is for active-duty service members, an eligible spouse of a veteran, or a veteran of the United States Armed Services. There are many benefits of a VA loan. A down payment is not required, and there is more flexibility if you have poor credit. If you have a VA loan, you don’t have to worry about paying mortgage insurance, and there is no prepayment penalty.
Are loans backed by the US Department of Agriculture. These loans are only given to those purchasing a home within specific areas, typically rural or remote areas of the country. There is no down payment requirement, and the mortgage insurance is less than what someone with an FHA loan would pay. However, the mortgage insurance is throughout the entire duration of the loan, which is unlike other loan options. There are various financial requirements that must be met as well, and the loan will only be issued if the property is your primary residence.
A bridge loan is a loan that is designed for a short time period. Typically, one would use a bridge loan as they work on more permanent financing options. These loans have higher interest rates, and typically need to be backed by the borrower's collateral or assets. In the real estate world, a bridge loan is used when there is a delay between selling a property you currently own, and purchasing a new property. For example, if your house is on the market and hasn’t sold yet, but you really want to buy a specific house, you may use a bridge loan to do so. Once your existing house sells, you’ll refinance through a regular mortgage.
A reverse mortgage allows a homeowner, who must be at least 62 years old, to receive cash for the equity they have in their home. To qualify for a reverse mortgage, the homeowner must own the house in full, or be very close to paying it off. Unlike a typical mortgage, a reverse mortgage doesn’t require the loan to be repaid via loan payments. Rather than paying monthly, a reverse mortgage loan amount is due when the borrower dies, moves away, or sells their home. This can be a great option if you need cash in your retirement years, and you already own your home.
Now You Know What Loan Options Are Available
There’s certainly a lot to the mortgage world, and many different options you can choose from. Given how important a mortgage is to your overall financial picture and life, it’s critical you understand all of your options before finalizing which mortgage type you’ll use to finance your home. A good mortgage broker will walk you through each option, can explain the pros and cons in greater detail, and will help you select the right option to fit your goals and requirements.
This page last updated: March 21, 2022