different types of mortgages
Almost everyone knows what a mortgage is – a type of loan secured by real estate or personal property – but how much do you know about the different types of mortgages available to a home buyer?
This is one of the most common questions we hear at Come Home to PA and the answer is really not as complicated as you may think.
First things first
The first thing to ask yourself is how much down payment you can afford.
If you can afford to put a lump sum down, that will give you a broader range of loans to choose from.
If not, you may be limited to certain types of loans that allow for a lower amount down, but there are still plenty of options.
Know your credit score before you start as well. Some loans have a minimum requirement and just won’t work if your score is borderline.
Another piece of information that will be important to know up front is your debt to income ratio. Learn how to calculate that here.
We’ve broken down the most common types of loans into a simple, quick reference chart and we explain each type of loan below. (If you are on a mobile device, you will see a list.)
If you can afford to put a lump sum down, that will give you a broader range of loans to choose from.
If not, you may be limited to certain types of loans that allow for a lower amount down, but there are still plenty of options.
Know your credit score before you start as well. Some loans have a minimum requirement and just won’t work if your score is borderline.
Another piece of information that will be important to know up front is your debt to income ratio. Learn how to calculate that here.
We’ve broken down the most common types of loans into a simple, quick reference chart and we explain each type of loan below. (If you are on a mobile device, you will see a list.)
| Loan Type | Fixed or Adjustable | Minimum Down Payment | Term in Years | Minimum Credit Score | PMI? | Typical DTI | Hard Limit DTI |
|---|---|---|---|---|---|---|---|
|
CONVENTIONAL FIXED |
Fixed |
3% |
10, 15, 20, 30 |
620 |
YES |
43% |
50% |
|
CONVENTIONAL ARM |
Adjustable |
10% |
Varies |
620 |
YES |
43% |
50% |
|
FHA (CREDIT 580+) |
Both |
3.5% |
15, 30 |
580 |
YES |
43% |
56.9% |
|
FHA (CREDIT BELOW 580) |
Both |
10% |
15, 30 |
500-579 |
YES |
43% |
56.9%
|
|
VA |
Both |
0% |
15, 20, 30 |
580 |
NO |
n/a |
47% |
|
USDA |
Fixed |
|
15, 30 |
620 |
NO |
41% |
44% |
Conventional Fixed
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Conventional ARM (Adjustable Rate Mortgage)
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FHA (Credit over 580)
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FHA (Credit between 500-579)
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VA (Veteran's Affairs)
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USDA
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*PMI can sometimes be removed after a certain loan to value ratio is met.
**DTI = Debt to Income Ratio
Figures listed are typical for the industry and should be treated as an estimate, loan programs can vary depending on the lender.
*PMI can sometimes be removed after a certain loan to value ratio is met.
While there are many factors that may affect which loan that works best for you, in some circumstances, your choices may be limited by the types of mortgage for which you qualify.
BASIC TYPES OF LOANS
There are a few basic concepts to understand before you dive deeper into the different types of loans available. And no, you don’t have to be an Einstein to understand it.
Fixed Rate Vs. Adjustable Rate
All mortgage loans have an interest rate and that rate can either be fixed, meaning it remains the same for the life of the loan, or it can be adjustable, meaning it changes based on whatever terms are set forth in the initial mortgage agreement.
Neither type is necessarily better than the other, there are benefits to both kinds of mortgages and much depends on your own individual financial situation as well as the market in which you are buying.
Neither type is necessarily better than the other, there are benefits to both kinds of mortgages and much depends on your own individual financial situation as well as the market in which you are buying.
Conventional Vs. Government Backed Loans
A conventional mortgage is, simply put, a mortgage that is not insured by the federal government.
It is instead available through private lenders, such as banks or mortgage companies, and can be backed by one of two government sponsored businesses, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
A government secured loan is guaranteed by the federal government.
There are three main types, insured by three different entities.
Each has a different purpose and a different set of rules for qualification.
None of them provide the money for the loan, they simple insure or guarantee repayment so that the lender can more confidently loan money.
They are:
It is instead available through private lenders, such as banks or mortgage companies, and can be backed by one of two government sponsored businesses, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
A government secured loan is guaranteed by the federal government.
There are three main types, insured by three different entities.
Each has a different purpose and a different set of rules for qualification.
None of them provide the money for the loan, they simple insure or guarantee repayment so that the lender can more confidently loan money.
They are:
FHA
The Federal Housing Administration
VA
The U.S. Department of Veteran's Affairs
USDA
The U.S. Department of Agriculture
Now that you understand the two main categories of loans, we can discuss each in more detail.
CONVENTIONAL LOANS, FIXED AND ARM (OR HYBRID)
A conventional mortgage is a loan that is not guaranteed by a government agency such as FHA, VA, or USDA.
A fixed conventional loan has an interest rate that remains the same (is fixed) for the life of the loan, while an ARM (adjustable rate mortgage) has an initial fixed rate period after which the interest rate adjusts annually.
Generally a conventional loan has higher standards for approval and qualification, so for many, it is not a viable option, but it is, overall, the most popular type of mortgage with over 76% of all loans falling under this category.
It seems the general public also has a taste for security, especially when it comes to their biggest personal investment.
96% of all mortgages are currently fixed rate, but this can change as interest rates rise and loans become less and less affordable.
That means that just 4% of all loans fall into the adjustable category.
A fixed conventional loan has an interest rate that remains the same (is fixed) for the life of the loan, while an ARM (adjustable rate mortgage) has an initial fixed rate period after which the interest rate adjusts annually.
Generally a conventional loan has higher standards for approval and qualification, so for many, it is not a viable option, but it is, overall, the most popular type of mortgage with over 76% of all loans falling under this category.
It seems the general public also has a taste for security, especially when it comes to their biggest personal investment.
96% of all mortgages are currently fixed rate, but this can change as interest rates rise and loans become less and less affordable.
That means that just 4% of all loans fall into the adjustable category.
Conventional Fixed
Conventional fixed loans are good for buyers with a stable employment history, strong credit, and a down payment of at least 3% or more.
PROS:
CONS:
Conventional ARM or Hybrid
An ARM can be great for those on the move. Anyone who plans to move within a few years might benefit from this type of mortgage by enjoying low initial payments and selling before the higher, fixed period begins.
The initial monthly payment on an ARM is less, so it saves you money up front.
Perhaps you are on the verge of a raise or are in school training for a better job. If you think you can afford more house down the road, an ARM could help get you into your dream house now. If your financial situation improves sooner, you can put your extra cash back into the loan to pay it off sooner.
An ARM is also good when the interest rate is high or in a market where home prices are almost out of reach for the typical buyer. It can make the initial payments affordable when they would not otherwise be so.
After the initial fixed rate period, you do take the chance that the interest rate will go up instead of down and your payment will increase quite a bit as you will start paying both interest and principal at this point. As such, many people will refinance into a regular fixed rate loan later on.
The initial monthly payment on an ARM is less, so it saves you money up front.
Perhaps you are on the verge of a raise or are in school training for a better job. If you think you can afford more house down the road, an ARM could help get you into your dream house now. If your financial situation improves sooner, you can put your extra cash back into the loan to pay it off sooner.
An ARM is also good when the interest rate is high or in a market where home prices are almost out of reach for the typical buyer. It can make the initial payments affordable when they would not otherwise be so.
After the initial fixed rate period, you do take the chance that the interest rate will go up instead of down and your payment will increase quite a bit as you will start paying both interest and principal at this point. As such, many people will refinance into a regular fixed rate loan later on.
PROS:
CONS:
Overall, while there are certain circumstances where an adjustable rate mortgage is the best choice, for the typical home buyer it includes an amount of risk that is unacceptable during periods of low interest.
GOVERNMENT INSURED MORTGAGES:
FHA, VA & USDA LOANS
Like conventional loans, some government insured mortgages are available with both fixed and adjustable rates.
But what makes these loans different is the lower requirements for qualification.
If you don’t meet all of the standards for a conventional loan, you’ll definitely want to look at one of these.
FHA, VA and USDA loans make it possible for millions of people to own a home who would not otherwise qualify for a mortgage.
26% of all loans issued are guaranteed by one of these agencies.
When should you look at an FHA, VA, or USDA loan?
Any time you are buying a house – not just when you don’t qualify for a conventional loan.
Though some of these loans have more fees over the life of the loan, they might still be a good choice depending on your situation, and for many, they are the only path to home ownership.
FHA, VA and USDA loans make it possible for millions of people to own a home who would not otherwise qualify for a mortgage.
26% of all loans issued are guaranteed by one of these agencies.
When should you look at an FHA, VA, or USDA loan?
Any time you are buying a house – not just when you don’t qualify for a conventional loan.
Though some of these loans have more fees over the life of the loan, they might still be a good choice depending on your situation, and for many, they are the only path to home ownership.
FHA Loans
An FHA loan has the broadest requirements for both the borrower and the property.
A large percentage of government loans are backed by the FHA.
FHA backed loan can offer a path to home ownership when you don’t qualify for a conventional loan.
FHA backed loan can offer a path to home ownership when you don’t qualify for a conventional loan.
PROS:
CONS:
VA Loans
If you are a member of the military (active duty, reserve, or veteran) you may want to consider a VA loan.
It is an excellent loan option available to those who have served their country.
Although applying for a VA loan can feel more complicated than other types of loans, an experienced lender can help make the process smooth.
What makes a VA loan different?
To begin with, there is no ongoing PMI, though there is a funding fee due up front which helps lessen the burden on taxpayers.
Additionally, a VA loan does not require a down payment and it is eligible for seller assist, so in the right circumstance, you could purchase a home with very little to no cash out of pocket. However, the total amount backed by the VA is capped and calculated based on your entitlement.
What is an entitlement? It is essentially an amount that the VA guarantees to the lender.
Remember, the lender is funding the loan, the VA is simply guaranteeing that they will recoup a certain percentage of their investment in case of default. The current entitlement is $36,000 or 25% of the mortgage. Lenders will typically loan up to four times the basic entitlement, so they would fund a loan for $144,000. An entitlement doesn’t lower the amount that you owe, it simply insures a portion of your repayment.
In many areas this is not enough to cover the cost of a basic home as prices rise, so the VA has instated a second, bonus entitlement to help cover the costs. The bonus entitlement is worth $85,087. Combined with the basic entitlement, that makes a total entitlement of $121,087.
Since a lender will typically loan up to four times the entitlement, that means you can finance up to $484,350. It is not a coincidence that is the same amount as the cap on FHA backed loans.
That said, you can still buy a house that costs more, you will just have to make up the difference in the form of a down payment.
Although applying for a VA loan can feel more complicated than other types of loans, an experienced lender can help make the process smooth.
What makes a VA loan different?
To begin with, there is no ongoing PMI, though there is a funding fee due up front which helps lessen the burden on taxpayers.
Additionally, a VA loan does not require a down payment and it is eligible for seller assist, so in the right circumstance, you could purchase a home with very little to no cash out of pocket. However, the total amount backed by the VA is capped and calculated based on your entitlement.
What is an entitlement? It is essentially an amount that the VA guarantees to the lender.
Remember, the lender is funding the loan, the VA is simply guaranteeing that they will recoup a certain percentage of their investment in case of default. The current entitlement is $36,000 or 25% of the mortgage. Lenders will typically loan up to four times the basic entitlement, so they would fund a loan for $144,000. An entitlement doesn’t lower the amount that you owe, it simply insures a portion of your repayment.
In many areas this is not enough to cover the cost of a basic home as prices rise, so the VA has instated a second, bonus entitlement to help cover the costs. The bonus entitlement is worth $85,087. Combined with the basic entitlement, that makes a total entitlement of $121,087.
Since a lender will typically loan up to four times the entitlement, that means you can finance up to $484,350. It is not a coincidence that is the same amount as the cap on FHA backed loans.
That said, you can still buy a house that costs more, you will just have to make up the difference in the form of a down payment.
PROS:
CONS:
USDA Loans
USDA backed loans are intended to help low to moderate income buyers who live in rural areas.
Unlike other types of loans, both the property and the buyer must qualify for a USDA backed loan.
The first thing to verify is whether or not the property you are looking at is located in an eligible area.
The USDA offers a property search on their website which makes determining eligibility simple.
Next, you must determine whether or not you are personally eligible to apply for this type of loan.
Income must be no higher than 115% of the adjusted area median income, which varies by county.
That’s some very specific data right there, but luckily, you can search that on their website as well.
Click here to view USDA eligible areas and to calculate personal income eligibility.
Unlike other types of loans, both the property and the buyer must qualify for a USDA backed loan.
The first thing to verify is whether or not the property you are looking at is located in an eligible area.
The USDA offers a property search on their website which makes determining eligibility simple.
Next, you must determine whether or not you are personally eligible to apply for this type of loan.
Income must be no higher than 115% of the adjusted area median income, which varies by county.
That’s some very specific data right there, but luckily, you can search that on their website as well.
Click here to view USDA eligible areas and to calculate personal income eligibility.
PROS:
CONS:
For a select group of people in certain areas, this type of loan may be the best option but the requirements are strict.
choosing a lender
Obtaining a home loan doesn’t have to be frustrating, but there are many different ways to break it down and every situation is different, so after you’ve read this article, your next best bet is to speak to a lender directly.
If you think you’ve narrowed down the type of mortgage that is right for you, search for someone locally who offers that type of mortgage. Your real estate agent can usually give you a few recommendations but you are never obligated to use one lender over another – the choice is always yours.
And while you can sometimes have a smooth transaction with a big online bank, I do recommend finding a local mortgage broker or lender with whom you can speak in person. Out of state banks don’t always get all the details of settlement right in your particular state and having someone local not only gives you a real live person to turn to, there’s a much better chance that lender will be prepared to close on a property in your specific location.
If you find a deal online that is just too good to be true, shop it locally, you might be surprised to find that a local lender can meet or beat the terms.
If you think you’ve narrowed down the type of mortgage that is right for you, search for someone locally who offers that type of mortgage. Your real estate agent can usually give you a few recommendations but you are never obligated to use one lender over another – the choice is always yours.
And while you can sometimes have a smooth transaction with a big online bank, I do recommend finding a local mortgage broker or lender with whom you can speak in person. Out of state banks don’t always get all the details of settlement right in your particular state and having someone local not only gives you a real live person to turn to, there’s a much better chance that lender will be prepared to close on a property in your specific location.
If you find a deal online that is just too good to be true, shop it locally, you might be surprised to find that a local lender can meet or beat the terms.
