An Overview of Different Mortgage Types
Buying a home is one of the biggest purchases you will ever make. Your dream home will not stay on the market forever, and chances are that you do not have the money to pay for a house in full right now. This means you need to take out a mortgage. The key is knowing what type of mortgage is best for you and your situation.
A mortgage is any loan where a home’s current or potential equity is used as collateral. There are a plethora of different types of mortgages to choose from and understand before you start the process. There are a variety of reasons you may be looking for a mortgage, such as:
• Purchase a primary home, a secondary home, or investment property
• Purchase a home in a certain area
• Purchase a home as a member of a certain ethnic group
• Purchase a home based on your economic status
• Purchase a home to fix and flip
Getting the right type of mortgage depends on who you are as a borrower and what your plans are for the home. Are you a first-time borrower? Do you have good or bad credit? How much money do you have for a down payment? Are you in the military or a veteran? What is your monthly income? These are just a few of the questions a mortgage broker will ask you when you are seeking a mortgage.
It’s important to clearly understand the different types of mortgage products so that you know what will work for you. Be as detailed as possible about what you want the mortgage for, your income, your debt, and your credit. Based on your answers, your mortgage broker will match you with the appropriate type of mortgage. Here are descriptions of a few mortgage options:
A conventional fixed-rate loan is the most popular type of mortgage. A 30-year conventional loan is the standard type of mortgage, but there are also 15-year and 20-year conventional loans. This type of mortgage is suitable if you expect to live in your home for a long time. 30-year conventional loans have attractive interest rates and affordable stable monthly payments. 15-year or 20-year conventional loans are primarily used to refinance a 30-year mortgage.
To qualify for a conventional mortgage, you need a minimum credit score of 620 with a low debt-to-income ratio. The most important thing you need to obtain this type of loan is to have a minimum 20 percent down payment for the home purchase. If you do not have a 20 percent down payment, then you will have to get private mortgage insurance. PMI protects the lender in case your home goes into foreclosure, but it will increase your mortgage balance and monthly payment.
Read more about conventional mortgages here.
If you do not have a 20 percent down payment and do not want to purchase a PMI policy, then you may qualify for a Federal Housing Authority loan. FHA loans are mortgages that have the backing of the U.S. government. You are only required to have a 3.5 percent down payment, and credit requirements are less stringent.
Most of the other types of mortgages can qualify as an FHA loan. You are limited to how much money you can borrow on an FHA loan, and you are still required to pay a mortgage insurance premium if your down payment is less than ten percent of the home’s value.
Read more about FHA loans here.
This type of home loan is backed by the Department of Veterans’ Affairs. VA loans offer 100 percent financing with no money down to members of every branch of the armed forces, veterans, surviving spouses, and certain people who work for defense-related organizations.
VA loans have four primary limitations, which include:
• Non-military members and non-veterans are not eligible
• No investment property purchases
• Cannot purchase a secondary home if primary home benefits have been exhausted
• Members of the military and veterans cannot exhaust any other benefits
The no down payment benefit of a VA loan has one major drawback. If the real estate market goes down, you could be underwater. This will prevent you from refinancing, getting cash out, and possibly selling your home.
Read more about VA loans here.
If you feel that the interest rate for a fixed-rate loan is a little too high, you can try to take advantage of an adjustable-rate mortgage. Initial interest rates for an ARM can be slightly lower than a fixed-rate loan. This low-interest rate is locked in for 3 to 5 years. Then it will switch to a floating interest rate that will adjust upward every 6 to 12 months until it reaches the maximum rate.
ARMs are best if you plan on moving within five years, do not qualify for a conventional loan, or you want to refinance to take advantage of a lower interest rate. If you want to refinance your home with an ARM, be sure to have plenty of equity in your home.
Read more about ARMs here.
Reverse mortgages are available to you if you are retired, 62 years of age or older, and need to borrow money for additional income. You can borrow money from your home’s equity without having to pay it back if you stay in your home. The amount you borrow cannot exceed the amount of equity you have in your home. The lump sum or monthly payments you receive are tax-free.
A reverse mortgage will make it impossible for you to give your home to your heirs as an inheritance. Your lender will have a lien on your home. After you pass away, your lender will sell your home and receive the proceeds from the sale. Also, if you move out of your home, you will have to pay back the amount you borrowed to your lender.
Read more about Reverse mortgages here.
If you are looking to purchase a luxury home, but don’t have the money to pay for it, then you may qualify for a jumbo loan. In general, jumbo loans apply to homes that are valued at $500,000 or more. Jumbo loans are not backed by the government, so credit requirements are more rigorous than conventional or FHA loans.
You will need to prove that you have the income that will cover the monthly payments while having a very low debt-to-income ratio. You can make a down payment as low as ten percent, but you will need to purchase a PMI policy for any down payment that is less than 20 percent.
Learn more about Jumbo loans here.
Balloon loans are short-term loans where the entire loan balance is due at the end of the term. This type of loan is typically offered to borrowers who have poor credit and need time to qualify for a loan with better terms. A balloon loan may have low interest-only payments, and the term can last anywhere from one to ten years. Interest-only payments are expensive over the long-term, so it’s important to refinance a balloon loan as soon as possible.
One of the most common types of balloon loans is hard money loans. Hard money loans have interest-only payments and have a one-year term. This type of loan is almost exclusively used by real estate investors and developers who need quick access to capital to purchase a home for a fix-and-flip project.
USDA rural housing loans
The Rural Housing Service manages a home loan program for the United States Department of Agriculture. This loan program offers 100 percent financing for first-time home buyers who are seeking to live in a rural area or small community. You must show that you have a financial need, have a low or modest income, and you must show that your current living condition is inadequate.
USDA rural housing loan rates are competitive, the mortgage insurance is inexpensive, but the loan amounts are relatively low. There is a waiting period for this loan, and most lenders do not offer this type of mortgage. Also, there are many suburban areas that are considered rural, so you may qualify for this loan and still find a home in a modest-sized city.
Indian home loan guarantee
Members of federally recognized American Indian or Alaska Native tribes are eligible for the Section 184 Indian home loan guarantee program. Native Hawaiians have access to Section 184A home loan program. This program was established by Congress in 1992 to help increase home ownership among members of Native American communities and to increase their access to capital. A Section 184 loan can be used to:
• Purchase an existing home
• Construct a new home
• Renovate or rehab a home
• Refinance a home
Native American tribal members can use this loan on or off native lands. Tribal members must live in an eligible state and county, and they must work with a participating lender. Section 184 only offers fixed-rate loans and is limited to single-family homes that are 1-4 units. Limits on the maximum loan amount vary by county.
203k rehab loans
The FHA 203k loan is the only type of loan that provides you with the money to purchase a home and make home improvements. This loan is available to you if you are an owner/occupant of a residential property. Real estate investors and developers are not eligible for this loan. Interest rates can be fixed or variable, but rates are slightly higher than conventional loans. The down payment can be as little as 3.5 percent.
You must hire a licensed contractor because you are not allowed to do your own renovations with this loan. The money for renovations is held in an escrow account and is paid directly to the contractor. 203k loans also pay for temporary housing while your home is undergoing renovations. The renovations must be completed within six months.
Read more about 203k rehab loans here.
There are always different types of mortgages being added and there are probably some that we did not cover here. I will do my best to update this list over time and will continue to add overviews of other products. This is why it is so important that you do the research upfront. Be sure to ask for advice on which lender to work with from your real estate agent, insurance broker, and financial adviser. Professionals in these professions should help to ensure that you are getting the best possible product for your situation. There is no “one best mortgage solution”.