8 Types of Mortgages
Home loan options can be bewildering.
Do you need an interest-only loan, a conventional fixed loan, an FHA loan, or a VA loan?
When looking for your dream home, there are a lot of home loan products to choose from. We'll break down the eight most popular types of mortgages so you can make an informed decision and get started on making homeownership a reality.
Who are Fannie Mae and Freddie Mac?
You'll hear these two names often when researching loans for a new home or refinancing a loan. Let's meet these two and learn their essential role in mortgages.
More commonly called Fannie Mae, the Federal National Mortgage Association (FNMA) is a government-sponsored enterprise (GSE). Fannie Mae purchases mortgage loans from larger financial institutions and will back these loans for borrowers considered on the low- or median-income level. Fannie Mae-backed loans are usually conventional.
Federal Home Loan Mortgage Corporation (FHLMC) more well-known as Freddie Mac purchases loans from smaller banks and credit unions. Most FHLMC-backed loans are conventional.
If it is important to know where your mortgage comes from, either a big bank or a smaller credit union, understanding the differences between Freddie Mac and Fannie Mae will help when talking with your lender.
Conventional Fixed-Rate Loans
Conventional loans are a popular loan option to consumers. These loans are not backed by the federal government, like an FHA or VA loan (more on these two later). A fixed-rate loan will mean no rate fluctuation; it is fixed. Conventional loans are often categorized as non-conforming and conforming.
Conventional Conforming Loans
- Conform to a set of standards established by the Federal Housing Finance Agency (FHFA).
- Tend to have higher interest rates than FHA and VA loans.
- You'll need to complete a mortgage application through a private lender or government-sponsored organizations such as Fannie Mae and Freddie Mac.
Conventional Non-conforming Loans
- Any loan that does not conform to the standards established by FHFA.
- Can include jumbo loans (a large loan that will exceed loan limits set by FHFA) and government-backed loans such as FHA and VA
- Used for a first or second home or investment property.
- Borrowing costs are lower than most other types of mortgages.
- You'll have the same payments throughout the loan.
- You can cancel private mortgage insurance (PMI) when you achieve 20% equity.
- A higher FICO credit score is needed.
- A higher down payment is needed.
- Will need PMI if a down payment is less than 20%.
Conventional Fixed-rate Terms
Conventional fixed-rate terms vary from 10,15, 20, 30- to 40-year durations. 15 and 30 are the most popular.
A conventional fixed-rate loan is good if you have a healthy credit score and have the funds to drop a sizeable down payment.
Adjustable-rate mortgages (ARMs) will have an adjustable rate. This means you start with a lower interest rate, but the rate may go up or down at some point. Interest rates rise and fall due to supply and demand. When there is an increase in the supply for credit, interest rates will drop. Higher interest rates mean that the supply of credit is decreasing. All interest rates are reset at specific intervals and are applied to the mortgage balance.
- This may be a good option if you plan on paying off the mortgage or selling within a short period.
- The most significant risk to adjustable-rate mortgages is that monthly payments could grow unaffordable, putting you at risk of losing your home or getting into debt.
If you are in a situation where you won't be living in the area for long, an ARM might be a good option. Be aware of the potential for ARM interest rates to soar, and could make paying your mortgage every month a hardship. Think carefully about taking on an adjustable-rate mortgage.
Interest-only mortgages appeal to borrowers because of the option to only pay on the loan's interest. At first, you may have low monthly payments, but you'll start paying on both the principal and the interest after the interest-only period ends. Plus, interest-rate only loans are ARMs, meaning if interest rates rise even during the interest-only period, the payment will be higher.
- Interest-only period lasts ten years
- Low monthly payments
- Could pay off a loan faster
- Interest-only period lasts ten years
- Low payments are only temporary
- It can be hard to qualify
- Will need a high credit score
- Variable interest rates
- Won't build equity until you are out of the interest-only period
Bottom LineAn interest-only mortgage might be a good option if you don't plan on owning the home for an extended period. Talk with a lending expert to learn about interest-only mortgages.
A Federal Housing Administration (FHA) mortgage loan is government-backed, meaning that the loan is insured by a federal agency such as FHA, the U.S. Department of Agriculture (USDA), or the Veterans Administration (VA). FHA loans are a flexible choice for first-time home buyers and those with a lower credit score.
- No large down payment
- Relaxed credit qualifications
- A higher debt-to-income ratio
- Some closing costs can be financed
- Friendly to first-time homebuyers
- Good for those who can't qualify for a conventional loan
- A bankruptcy or foreclosure is not a disqualification
- There are loan limits to FHA loans
- Can come with higher interest rates
- Cannot be used for investment properties
- Mortgage insurance is non-negotiable
- Home appraisals go through a strict process before a loan is approved
It's important to note that if you're trying to buy a home in a hot seller's market, FHA loans are not as attractive to sellers. FHA loans can cause delays and be viewed as risky. Having an FHA loan could mean losing out to a conventional loan holder.
FHA loans are a flexible choice for potential home buyers. And, if your credit score is not great, FHA might be a loan program to research first.
VA (Veteran's Administration) loans are for eligible active-duty members of the military, a surviving spouse, or a veteran. VA loans could be a great option if you fit these and other requirements. As with any loan program, it's essential to look over all your options. There may be other options outside of a VA loan that could give you an even better rate and save even more money.
- Lower rates
- Flexible financing
- Relaxed credit requirements
- No down payment required
- No mortgage insurance is needed
- Good choice for those with a bankruptcy or foreclosure
- VA funding fees are required (but can be financed into the loan)
- Cannot waive an inspection or appraisal
- Sellers can find VA loans as less desirable than conventional ones
- Cannot use a VA loan on investment or vacation properties
Bottom LineLike FHA loans, some sellers find VA loans a deal-breaker. Sellers may find the strict guidelines confusing, the closing process too long, and other issues. Also, if the home is in a hot market, a VA loan may be passed over for a more conventional loan with fewer restrictions or requirements to process.
USDA loans are backed by the USDA and are for families buying homes in rural or suburban areas. This loan type can be a good choice for low-income to moderate-income homebuyers. If you've always dreamed of living on a farm or rural area, this could be the loan to research. These loans aren't exclusive to rural areas; homes in suburban areas may also qualify.
- No down payment or cash reserves required
- Low-interest rates
- Relaxed credit requirements
- Can pass the cost of the appraisal to buyer
- Option for seller to pay closing costs
- Can pay off a loan with no penalty
- Option to finance in repairs and closing costs into the loan
- Use the loan to build a home on the property
- Property must fall within specific geographical areas
- Mortgage insurance is needed
- Cannot exceed income limits established by the USDA
- Cannot use a USDA loan to purchase a commercial farm
Bottom LineUSDA loans are not limited to farms or ranches. A USDA loan can be used for an existing home, modular homes, new construction, and other home types. There are income and geographical restrictions that you'll need to know before applying. Approval for a USDA loan typically takes 30-60 days.
Balloon mortgages allow homebuyers to have a low-interest rate on a fixed-rate loan but with a short term, usually 5, 7, or 10 years. These loans will enable the homeowner to make a monthly payment of interest only or principal with interest. After the term, however, the mortgage holder will need to make a "balloon payment," which includes all of the outstanding principal. These loans allow buyers to buy a home they may not afford through more conventional loan programs.
- Low-interest rate
- Short loan terms
- Allows the buyer to purchase more home than a conventional loan.
- No equity
- Hard to refinance
- Higher risk of foreclosure
Bottom LineBalloon mortgages are one of the more risker mortgage options available. If you think you'll sell before the balloon payment is due and the real estate market crashes in your area or personal reasons make you unable to sell, you'll be faced with a large payment.
Jumbo loans are used to finance a home that exceeds the conventional loan limits set by the FHFA. These loans can be fixed or adjustable and are typically used for expensive home purchases.
- May qualify for less than 20% down
- VA jumbo loans are available
- Allows consumers to buy a bigger home in a more desirable area
- Higher closing costs
- Higher interest rates
- Proof of high income and a low-debt to income ratio
- A large amount of cash is needed in reserves
- Need a high credit score to qualify, upwards of 700s
- Will not be guaranteed through Fannie Mae or Freddie Mac
Bottom LineJumbo loans are a good option if you want to buy a home in a more expensive neighborhood that a conventional loan wouldn't allow. Like a balloon mortgage, they come with risks more significant than a conventional loan. You can check the conforming loan limit for all U.S. counties at the FHFA website.
Weighing the pros and cons of different mortgage types will help you find the right mortgage. As you do your research, ask yourself:
- How much home can I afford?
- Am I willing to move to a different area or state?
- What type of loan is best for me now and in the future?
- Who do I want to finance my loan, a big bank or a credit union?