Types of Mortgage Loans for Homebuyers

Talia Lee-
June 12, 2024

Most of us require a mortgage to purchase a home, but these loans aren’t one-size-fits-all. To assist you in finding the right home loan for your needs, here’s a guide to the five main types of mortgages.

There are five main types of mortgages, each with its own benefits and features:

  • Conventional loan: Ideal for borrowers with good credit scores.
  • Jumbo loan: Suitable for borrowers with good credit looking to purchase a more expensive home.
  • Government-backed loan: Perfect for borrowers with lower credit scores and minimal cash for a down payment.
  • Fixed-rate mortgage: Great for borrowers who prefer predictable, set monthly payments throughout the loan term.
  • Adjustable-rate mortgage: Best for borrowers not planning to stay in the home long-term, those who prefer lower initial payments, or those comfortable with potential future payment increases.

Conventional loans, the most popular type of mortgage, come in two categories: conforming and non-conforming.

Conforming loans: These loans adhere to the Federal Housing Finance Agency (FHFA) standards, including guidelines around credit, debt, and loan size. When a loan meets these criteria, it’s eligible to be purchased by Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that dominate the mortgage market.

Non-conforming loans: These loans do not meet one or more of the FHFA’s standards. A common example of a non-conforming loan is a jumbo loan, which exceeds the conforming loan limit. Since non-conforming loans can’t be purchased by the GSEs, they are considered riskier for lenders.

Pros of conventional loans:

  • Available from the majority of lenders
  • Can be used to finance primary residences, second homes, and investment properties
  • Down payments can be as low as 3% for a conforming, fixed-rate loan

Cons of conventional loans:

  • Require a credit score of at least 620 to qualify
  • Have a lower debt-to-income (DTI) ratio threshold compared to other mortgage types
  • Require private mortgage insurance (PMI) premiums if the down payment is less than 20%

Who are conventional loans best for?

Conventional loans are ideal for those with strong credit scores and the ability to make a sizable down payment.

“Conventional loans are flexible and suitable for a wide range of homebuyers, especially those with good-to-excellent credit scores, stable income, and some savings for a down payment,” says Matt Dunbar, senior vice president of Southeast Region for Churchill Mortgage. “These loans offer competitive interest rates and flexible terms, making them attractive to buyers who meet the qualification criteria.”

Among conventional mortgages, the 30-year fixed-rate option remains the most popular choice for homebuyers.

Jumbo mortgages are home loans that exceed the Federal Housing Finance Agency (FHFA) conforming loan limits. In 2024, this means any loan over $766,550, or $1,149,825 in higher-cost areas. Since these loans are larger and can’t be purchased by government-sponsored enterprises (GSEs), they carry more risk for lenders.

Pros of Jumbo Loans:

  • Can finance a more expensive home
  • Competitive interest rates, often on par with conforming loans
  • Often the only option in high-value home markets

Cons of Jumbo Loans:

  • Not available with every lender
  • Higher credit score requirement, typically a minimum of 700
  • Higher down payment requirement, usually 10% to 20%

Who are jumbo loans best for?

Jumbo loans are ideal for buyers looking to finance a home with a purchase price exceeding the current conforming loan limits.

“These loans are best for buyers in high-cost real estate markets who need larger amounts,” says Matt Dunbar, senior vice president of Southeast Region for Churchill Mortgage. “Homebuyers considering a jumbo loan typically have excellent credit, a low debt-to-income ratio, and substantial assets.”

While the U.S. government doesn’t directly lend money for mortgages, it supports homeownership through backing three primary types of loans:

FHA Loans: Insured by the Federal Housing Administration (FHA), these loans are accessible with a credit score as low as 580 and a 3.5% down payment, or a score as low as 500 with a 10% down payment. FHA loans require mortgage insurance premiums, which increase costs but protect lenders against defaults. Additionally, FHA loan limits are lower than conventional conforming loan limits.

VA Loans: Guaranteed by the U.S. Department of Veterans Affairs (VA), these loans are available to eligible U.S. military members (active duty, veterans, National Guard, and Reservists) and surviving spouses. VA loans require no minimum down payment, no mortgage insurance, and no credit score requirement, but a funding fee ranging from 1.25% to 3.3% is payable at closing.

USDA Loans: Guaranteed by the U.S. Department of Agriculture (USDA), these loans assist moderate- to low-income borrowers in purchasing homes in rural, USDA-eligible areas. USDA loans don’t have a credit score or down payment requirement but do charge guarantee fees.

Pros of Government-Backed Loans:

  • More flexible credit and down payment requirements
  • Accessible to borrowers who might not qualify otherwise

Cons of Government-Backed Loans:

  • Additional costs for FHA mortgage insurance, VA funding fees, and USDA guarantee fees
  • Limited to borrowers within FHA loan limits, in rural areas, or eligible servicemembers

Who are government-backed loans best for?

Government-backed loans are ideal for those who may not qualify for conventional loans due to credit or down payment constraints. FHA loans are attractive for those with lower credit scores or smaller down payments. VA loans cater to military members and their families, while USDA loans are geared toward buyers in rural areas.

“Government-backed loans typically target a specific demographic,” says Darren Tooley, senior loan officer at Cornerstone Financial Services. “For example, VA loans offer special financing only available to veterans, active-duty military personnel, and eligible surviving spouses, while USDA loans are for homebuyers purchasing homes in specially designated rural areas. Additionally, FHA loans offer a great alternative to conventional financing and may be a lower rate option for those who either have below-average credit or a smaller down payment.”

Fixed-rate mortgages maintain the same interest rate for the entire term of your loan, ensuring that your monthly mortgage payment (principal and interest) remains constant. These loans typically come in 15-year or 30-year terms, though some lenders offer flexible term lengths.

Pros of Fixed-Rate Mortgages:

  • Consistent monthly mortgage payment
  • Easier to budget for long-term

Cons of Fixed-Rate Mortgages:

  • Higher interest rates compared to initial rates on adjustable-rate loans
  • Must refinance to secure a lower rate

Who are fixed-rate mortgages best for?

If you plan to stay in your home for a considerable time and want a stable monthly payment (excluding potential increases in homeowners insurance premiums and property taxes), a fixed-rate mortgage is ideal.

“Fixed-rate mortgages are perfect for those seeking the security of knowing their interest rate and monthly payment will remain unchanged year after year, unless they choose to refinance,” says Darren Tooley, senior loan officer at Cornerstone Financial Services.

Adjustable-rate mortgages (ARMs) come with interest rates that change over time. Typically, ARMs offer a lower fixed introductory rate for a set period, after which the rate adjusts at predetermined intervals based on economic conditions. For instance, a 5/6 ARM has a fixed rate for the first five years; thereafter, the rate adjusts every six months until the loan is paid off. When the rate increases, so does your monthly mortgage payment, and vice versa.

Pros of ARMs:

  • Lower introductory rates
  • Potential for lower payments over time if interest rates fall

Cons of ARMs:

  • Risk of higher monthly payments
  • Less predictable budgeting due to rate changes

Who are adjustable-rate mortgages best for?

If you don’t plan to stay in your home for more than a few years, an ARM could save you money on interest payments. However, you must be comfortable with the risk that your payments might increase if you’re still in the home when the rate adjusts.

“ARMs are suitable for buyers who expect to move or refinance before the initial fixed period ends,” says Matt Dunbar, senior vice-president of Southeast Region for Churchill Mortgage. “This includes professionals who relocate frequently, individuals anticipating significant income increases, or those planning to sell their home within a few years.”

In addition to these common types of mortgages, you might also come across other options when shopping for a loan:

If you plan to build a home, a regular mortgage won’t suffice since there’s no property yet to secure the loan. Instead, you can opt for a construction loan, particularly a construction-to-permanent loan, which transitions into a traditional mortgage once you move into the completed home. These short-term loans are ideal for those who can afford a higher down payment.

With an interest-only mortgage, borrowers make payments covering only the interest for a specified period, typically five or seven years, before transitioning to payments covering both principal and interest. These loans suit individuals confident they can sell or refinance or anticipate affording higher payments later.

Piggyback loans, also known as 80/10/10 loans, involve two loans: one covering 80 percent of the home price, the other 10 percent, with the borrower responsible for the remaining 10 percent as a down payment. They aim to help avoid mortgage insurance or needing a jumbo loan but come with two sets of closing costs.

Balloon mortgages entail making payments based on a 30-year term for a short period, like seven years, followed by a substantial payment of the remaining balance. Without proper preparation, this final payment can be daunting.

Portfolio loans, held by lenders instead of being sold to investors, aren’t subject to FHFA or similar standards, potentially leading to more flexible qualifying criteria. However, they may come with higher fees due to the lender’s retention of these loans.

Renovation mortgages are ideal for purchasing homes in need of substantial repairs, as they encompass both the home purchase and renovation costs within a single mortgage.

Physician loans cater specifically to medical professionals burdened by significant medical school debt, offering flexibility regarding income, assets, credit history, and debt load, making home ownership more accessible.

Non-qualifying mortgages (non-QM) don’t meet specific standards outlined by the Consumer Financial Protection Bureau, allowing for more relaxed credit and income criteria. While beneficial for borrowers with unique circumstances like irregular earnings or foreign income, these loans may entail higher down payments and interest rates.

Depending on your credit and financial situation, multiple mortgage options may be suitable for you. However, certain loan types may be immediately ruled out based on eligibility criteria. For instance, VA loans are exclusive to military service members and their spouses.

Understanding the nuances of conventional loans, jumbo loans, government-backed loans, fixed-rate mortgages, and adjustable-rate mortgages is crucial, emphasizes Dunbar. Each type offers distinct benefits tailored to diverse financial circumstances and objectives. It’s essential to assess the total loan cost over time, encompassing interest payments and fees.

When deliberating on the mortgage type to pursue, consider the following factors:

  • Credit score: Determine which loan types align with your creditworthiness.
  • Down payment: Evaluate whether you require a low- or no-down payment loan and explore options for down payment assistance or gift funds.
  • Debt and income: Ensure your monthly income is adequate to cover mortgage payments after accounting for existing debts.
  • Risk tolerance: Decide if you prefer a consistent monthly payment or are willing to accept fluctuations.
  • Future plans: Consider your relocation plans and whether you aim to pay off the mortgage earlier than the standard term.

After assessing these factors, compare mortgage lenders and engage with loan officers to identify the most suitable option and navigate the mortgage application process effectively.

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