It’s 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. Once you understand the loans, 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 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 higher credit score. The higher your credit score, the more preferential your interest rate is likely to 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 (FHFA). There are various underwriting requirements that must be met: 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 government regulated Fannie Mae’s or Freddie Mac’s standards.
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 a mortgage loan the government insures or guarantees 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 defaults 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 in the different home loan options sections.
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 an additional amount determined by 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. A lender will require you to carry mortgage insurance if your down payment is less than 20% of the home selling price.
For example, a person can put a down payment of 5% on a home and until the homebuyer’s equity in the home reaches 20%, the homebuyer will be required to pay between 0.5% to 1.5% of the loan amount toward mortgage insurance each year. These payments are typically included in your monthly mortgage statement.
It’s important to note, mortgage insurance does not protect you, the borrower. Instead, it is something the borrower pays that insures the lender. If you default on the loan, the lender 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 popular loan options. A fixed-rate loan has an interest rate that does not change throughout the entire life of the loan. The interest rate remains fixed for the duration of the loan, which provides a huge benefit from a budgeting perspective, because this means your interest rate cannot increase.
It’s also common to see fixed-rate loans apply to the various other types of borrowing: student loans, personal loans, and even auto loans.
Adjustable-Rate Mortgages (ARM)
Also known as a variable-rate mortgage, an adjustable-rate mortgage (ARM) has an interest rate that can change 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, because your rate could decrease, saving you money. But if the initial 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 a mortgage used to finance properties that exceed the criteria and limits of the FHFA. The properties purchased with these loans tend to be expensive, and as a result, the borrower must meet specific criteria to get approved for these loans.
An example of a jumbo loan would be if someone was buying a home that costs $1,250,000. 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 anyone working to repair their credit and financial situation. FHA loans do come with mortgage insurance, which again, protects the lender, not the homeowner.
A VA loan is for active-duty service members, an eligible spouse of a veteran, or a veteran of the United States Armed Services. VA loans come with a variety of benefits.
VA loans don’t require a down payment, and there is more flexibility if you have poor credit. If you get a VA loan, you don’t have to worry about paying mortgage insurance, and there is no prepayment penalty.
USDA loans are mortgages 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.
These loans don’t require a down payment, and the mortgage insurance is less than what someone with an FHA loan would pay. However, unlike other loan options, the mortgage insurance runs throughout the entire duration of the loan. Also, various financial requirements 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 designed for a short time period. Typically, one would use a bridge loan as they work on more permanent financing options. These loans tend to 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 That You Know, What’s Next?
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 can walk you through each option, explain the pros and cons in greater detail, and help you select the loan that best fits your goals and requirements.
This page last updated: October 18, 2022