Are you thinking of getting a mortgage loan? Do you have no idea what type of mortgage loan to go for? I’m sharing different types of mortgage loans in this post, you’ll find it educative.
I’m going to list the different types of mortgage loans and explain the advantages and disadvantages of each to help you make an informed decision.
Mortgage Loans Explained
A mortgage loan is a loan that is used to purchase a home. Mortgage loans should not be confused with home equity loans, which are also secured against the home and have similar interest rates but are different in other ways.
When you purchase a home, you will need to borrow money from a lender. The lender will lend you a certain amount of money, and you will pay them back over time with interest.
This type of loan is known as a mortgage loan because it is secured by your house; if you fail to make the payments on your mortgage loan then the lender can foreclose on your house and sell it—using the proceeds from the sale to pay off the balance of your mortgage loan and any other debts that you may owe the lender.
Most homes in developed countries are purchased using some form of mortgage loan.
Now, let’s take a look at the different types of mortgage loans.
9 Different Types of Mortgage Loans
FHA mortgages can be a great option for first-time homebuyers who may not have the credit or financial resources to qualify for a conventional mortgage. The government program makes it easier for these home buyers to get approved for loans and more affordable for them to purchase homes.
Homebuyers with FHA mortgages can get lower interest rates than borrowers with conventional mortgages. Additionally, closing costs are typically less expensive with an FHA loan.
An FHA mortgage is insured by the U.S. Federal Housing Administration (FHA), which means that if you default on your loan, the agency will reimburse your lender the money you owe on your home.
This insurance helps you get approved for a loan even if you have a low credit score or don’t have much of a down payment.
FHA loans are typically issued by private lenders, and they’re available to both first-time home buyers and people buying second homes.
The Federal Housing Administration (FHA) provides mortgage insurance on loans with down payments as low as 3.5 percent and interest rates as low as 3.375 percent for first-time home buyers and repeat home buyers.
FHA loans require little to no money out of pocket at closing, and some FHA loans are assumable, which means that when you sell your home you can easily pass the loan along to the new buyer.
The FHA does not charge mortgage insurance on loans if the borrower has a 20 percent down payment or more, but lenders may still require borrowers to pay for private mortgage insurance if there is less than a 20 percent down payment.
Because of this incentive, many FHA loans are hybrid loans with both an FHA component and a traditional component.
FHA loans are also known as conventional loans, while non-FHA loans are also known as “conforming” loans because they conform to guidelines set by the government-sponsored enterprises (GSEs), which include Freddie Mac and Fannie Mae.
If you are a first-time homebuyer, you may be eligible to apply for a USDA mortgage.
This loan is backed by the government and has some unique benefits, including low down payment requirements and no private mortgage insurance (PMI).
The USDA (or the United States Department of Agriculture) loan program has been around since the 1930s and was originally intended for farmers. The program is designed to help low-income families purchase a home. The program offers loans to those who otherwise may not qualify for a conventional loan due to their credit score or down payment amount.
Tens of thousands of citizens in urban areas utilize rural areas as well as small cities, towns and villages benefit from this loan program and are able to purchase homes at an affordable cost.
The requirements for a USDA loan are similar to that of a conventional mortgage. However, there are some additional requirements that must be met in order to qualify for one. Some of those additional requirements include:
The home must be located in a rural area as defined by the USDA. This means that the property cannot be located within an urbanized area or municipality as defined by the Census Bureau which includes over 50,000 residents.
The property that you wish to purchase must also be located within an acceptable distance of business centers, schools, and medical facilities as they apply to your location.
HUD defines rural areas based on population density, distances between communities, and travel time needed in order to access public services such as health care facilities and shopping opportunities.
The USDA helps homebuyers with smaller down payments. The program has two parts: the direct loan, which is a mortgage guaranteed by the federal government, and the guaranteed loan.
USDA direct loan has no down payment required, while the guaranteed loan requires a down payment of at least 3%.
In addition to the low down payment, the USDA has certain eligibility requirements for income and home value.
They can vary from state to state. Some states allow condos and townhomes; others don’t. Check with the USDA for your state’s guidelines.
The other catch is that you have to live on the property for at least 5 years. If you sell before then, you face a penalty fee equal to 15% of the difference between what you sold it for and what you bought it for.
So if you bought a home for $100,000 and sold it for $150,000 five years later, you would have paid $15,000 in interest back to the government.
A jumbo mortgage is a type of home loan that is generally too large for government backing and falls outside the limits set by most conventional lenders.
Jumbo mortgages are typically taken out on particularly expensive homes, or when more money is desired than the conforming loan limit allows.
Because jumbo loans are non-conforming, they are not guaranteed by the Federal Housing Administration (FHA) or other agencies.
However, they do have their advantages and may be right for you if you need a large loan to buy a particular home or refinance an existing mortgage.
The amount of money you can borrow in a jumbo mortgage depends on several factors, including:
- Your credit score
- Your income
- Your down payment
- The value of your home
Because jumbo mortgages are not backed by the Federal Housing Administration (FHA), credit scores are vital to obtaining this type of loan.
You also must have enough income to repay the loan and a substantial down payment – at least 20%, for a lender to consider your application.
Conventional loans are the most common type of mortgage loan and are typically used by borrowers with good, stable credit.
Conventional loans typically require a down payment of at least 20 percent of the purchase price of a home.
The rest of the purchase price is covered by a combination of the mortgage amount and any cash that you have saved for this purchase.
In today’s market, conventional loans are the most common type of mortgage loan.
Conventional loans are originated by lenders (banks and mortgage companies) that have paid an insurance premium to the Federal Housing Administration (FHA).
However, the loan products are not insured or guaranteed by the federal government. Instead, each lender maintains its own standards for approving borrowers and making loans.
Because conventional loans are not insured or backed by HUD or any other government agency, they are commonly referred to as ‘non-government’ loans.
And while conventional loans don’t come with government backing, they often have more flexible requirements than FHA or VA loans.
For starters, conventional mortgages tend to offer lower down payment options than FHA or VA mortgages.
They also allow better credit scores than FHA or VA mortgages. And unlike VA mortgages, conventional loans can be used for refinancing purposes.
Unconventional loans are loans that don’t fall under the standard guidelines of your typical loans.
Unconventional loans may carry a higher interest rate. They are usually for a shorter length of time and have special stipulations that can differentiate them from a typical loan.
There is no set definition for unconventional loans, and each lender may have its own terms for its loan program.
If you are applying for an unconventional loan, it is important that you know the meaning of the word “unconventional”, and proceed with caution when applying for this type of loan.
A number of different types of loans can fall into the category of unconventional borrowing options. One of the most popular and most common types is a commercial mortgage.
Unlike typical residential mortgages, these are provided to business owners and investors who want to purchase property for their business-related needs.
Unconventional loans are often made for projects that might not be able to secure financing through more traditional means.
For example, if you’re trying to build a shopping mall in an area that doesn’t have adequate infrastructure to support it, then you may have trouble getting a loan from the bank due to the high risk involved in the project’s success.
Conversely, if you’re trying to refinance a house but don’t have enough equity in it (or aren’t able to pay off your current mortgage), then you may need an unconventional loan in order to get approved for more funding.
A fixed-rate mortgage is a home loan with a set interest rate that is locked in and remains the same throughout the life of the loan.
Unlike adjustable-rate mortgages, which change the interest rate periodically over time, a fixed-rate loan allows borrowers to know their monthly payments will not change unless they choose to refinance or pay off their mortgage.
The main advantage of fixed-rate loans is that they allow borrowers to budget more easily.
Since they know the exact cost of their mortgage, they can plan their monthly payments accordingly.
Fixed-rate mortgages are also easier for lenders to price and provide fewer opportunities for borrowers to take on more debt than they can afford.
Fixed-rate mortgages are popular because they allow borrowers to know exactly what their monthly mortgage payments will be.
The interest rate on a fixed-rate loan is a set amount for the life of the mortgage. This means there will be no surprises – your monthly payments will not change year after year.
There are many different types and lengths of fixed-rate mortgages. You can choose between a five-year fixed rate, a 10-year option, or even a mortgage that’s guaranteed for up to 25 years.
Your lender will help you determine which option works best for you and your mortgage goals.
Adjustable-rate mortgages, also known as ARMs, are mortgages whose interest rates can change periodically.
You might hear them called “variable-rate mortgages,” but that’s not technically accurate; these loans actually have fixed rates for the first few years, after which they adjust based on changes in an interest rate index like the Wall Street Journal Prime Rate or the London Interbank Offered Rate (LIBOR).
The advantage of an ARM is lower monthly payments when interest rates are low (or when you get a teaser rate that later reverts to market levels). The disadvantage is that you could wind up paying more if interest rates rise.
That’s because ARMs typically have caps on how high your payment can go, which means these loans let you borrow more money than you would with a fixed-rate mortgage (by the same amount).
Depending on the type of ARM you get, this might not be a problem — but some loans actually have caps on how low your rate can go, as well.
That’s not a problem when interest rates are falling, but it makes them riskier if your payments don’t adjust downward when rates start climbing again.
Adjustable rates are typically lower than fixed rates during their first year, so you’ll end up paying less in total interest during that time.
But after your first year, your mortgage holder may adjust your loan’s interest rate up or down in response to changes in market conditions — such as rising or falling mortgage rates — and it could increase by more than you’d pay on a fixed mortgage.
A reverse mortgage is a loan given to homeowners who are at the end of the line, and they don’t have to pay it back until they die, sell their home, or no longer live there.
If a homeowner’s house is paid for and insured, he or she could qualify for a reverse mortgage.
All the borrower has to do is pay property taxes and homeowner’s insurance on his or her home. The bank will then make payments directly to the borrower.
The loan is considered a last resort because the borrower does not have to repay any of the money taken out until he or she dies, sells the house, or moves out.
This makes the loan extremely risky for financial institutions. A homeowner has up to 15 years from when he or she receives the funds to pay off the loan.
During that time, interest and principal will accumulate. The borrower may lose his or her house if they do not take care of all of their payments on time.
Reverse mortgages can help you continue living independently in your own home as long as you like.
For many people, a reverse mortgage can be a powerful financial tool for meeting retirement needs.
Also Read: How to Get a Mortgage Loan
Conforming mortgages are the norm, not the exception when it comes to financing a home.
It is relatively easy to get a conforming mortgage for your home. The most common type of conforming mortgage is a 30-year fixed-rate mortgage.
Conforming mortgages are guaranteed by the government through either Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corporation).
They allow you to borrow up to the amount that your lender sets as the limit, or “conforming loan limit.”
This amount is determined by your location and the value of the house you want to buy.
Conforming loans are available in most areas of the United States. There is no maximum limit on how large a mortgage can be, but only conforming loans are eligible for government backing.
If you need to borrow more than conforming limits, you will have to go with a non-conforming loan.
Conforming mortgages are not limited to a specific type or number of properties or borrowers, so long as the property is owner-occupied. Conventional loans are sold to investors through various investment vehicles including bonds, MBS, or whole loans.
Conforming loans typically have a lower interest rate than jumbo loans and offer better terms because they are guaranteed by the government.
The limit on conforming loan amounts varies from time to time but for most of the past 10 years has been $417,000 in most parts of the United States.
Final Thoughts: Different Types of Mortgage Loans
I gathered these different types of mortgage loans so you can make a highly informed choice for your next mortgage decisions.
Also Read: How to Get a House with Bad Credit