Choosing among the different types of mortgage loans isn’t all that painful if you know the lingo. Here’s a primer on some of the most common types of mortgages.
Conventional loan
A conventional mortgage is a home loan that’s not insured by the federal government. There are two types of conventional loans: conforming and nonconforming loans.
A conforming loan simply means the loan amount falls within maximum limits set by the Federal Housing Finance Agency. The types of mortgage loans that don’t meet these guidelines are considered non-conforming loans.
Generally, lenders require you to pay private mortgage insurance (PMI) on many conventional loans when you put down less than 20 percent of the home’s purchase price.
Pros of conventional mortgages
- Can be used for a primary home, second home or investment property
- Overall borrowing costs tend to be lower than other types of mortgages, even if interest rates are slightly higher
- Can ask your lender to cancel PMI once you’ve reached 20 percent equity, or refinance to remove it
- Can pay as little as 3 percent down on loans backed by Fannie Mae or Freddie Mac
Cons of conventional mortgages
- Minimum FICO score of 620 or higher often required (the same applies for refinancing)
- Higher down payment than government loans
- Must have a debt-to-income (DTI) ratio of no more than 45 percent to 50 percent
- Likely need to pay PMI if your down payment is less than 20 percent of the sales price
- Significant documentation required to verify income, assets, down payment and employment
Jumbo loan
Jumbo mortgages are conventional types of mortgages that have nonconforming loan limits. This means the home price exceeds federal loan limits. For 2021, the maximum conforming loan limit for single-family homes in most of the U.S. is $548,250. In certain high-cost areas, the ceiling is $822,375. Jumbo loans are more common in higher-cost areas, and generally require more in-depth documentation to qualify.
Pros of jumbo mortgages
- Can borrow more money to buy a home in an expensive area
- Interest rates tend to be competitive with other conventional loans
Cons of jumbo mortgages
- Down payment of at least 10 to 20 percent needed
- A FICO score of 700 or higher typically required, although some lenders accept a minimum score of 660
- Cannot have a DTI ratio above 45 percent
- Must show you have significant assets (generally 10 percent of the loan amount) in cash or savings accounts
Government-insured loans
The U.S. government isn’t a mortgage lender, but it does play a role in helping more Americans become homeowners. Three government agencies back mortgages: the Federal Housing Administration (FHA loans), the U.S. Department of Agriculture (USDA loans) and the U.S. Department of Veterans Affairs (VA loans).
FHA loans – Backed by the FHA, these types of home loans help make homeownership possible for borrowers who don’t have a large down payment saved up or don’t have pristine credit. Borrowers need a minimum FICO score of 580 to get the FHA maximum of 96.5 percent financing with a 3.5 percent down payment; however, a score of 500 is
accepted if you put at least 10 percent down. FHA loans require two mortgage insurance premiums: one is paid upfront, and the other is paid annually for the life of the loan if you put less than 10 percent down, which can increase the overall cost of your mortgage.
USDA loans – USDA loans help moderate- to low-income borrowers buy homes in rural areas. You must purchase a home in a USDA eligible area and meet certain income limits to qualify. Some USDA loans do not require a down payment for eligible borrowers with low incomes.
VA loans – VA loans provide flexible, low-interest mortgages for members of the U.S. military (active duty and veterans) and their families. VA loans do not require a down payment or mortgage insurance, and closing costs are generally capped and may be paid by the seller. A funding fee is charged on VA loans as a percentage of the loan amount to help offset the program’s cost to taxpayers. This fee, as well as other closing costs, can be rolled into most VA loans or paid upfront at closing.
Pros of government-insured loans
- Help you finance a home when you don’t qualify for a conventional loan
- Credit requirements more relaxed
- Don’t need a large down payment
- Available to repeat and first-time buyers
Cons of government-insured loans
- Mandatory mortgage insurance premiums on FHA loans that cannot be canceled in some cases
- Could have higher overall borrowing costs
- Expect to provide more documentation, depending on the loan type, to prove eligibility
Fixed-rate mortgage
Fixed-rate mortgages keep the same interest rate over the life of your loan, which means your monthly mortgage payment always stays the same. Fixed loans typically come in terms of 15 years, 20 years or 30 years.
Pros of fixed-rate mortgages
- Monthly principal and interest payments stay the same throughout the life of the loan
- Can more precisely budget other expenses month to month
Cons of fixed-rate mortgages
- Generally need to pay more interest with a longer-term loan
- Takes longer to build equity in your home
- Interest rates typically higher than rates on adjustable-rate mortgages (ARMs)
Adjustable-rate mortgage
Unlike the stability of fixed-rate loans, adjustable-rate mortgages have fluctuating interest rates that can go up or down with market conditions.
Many ARM products have a fixed interest rate for a few years before the loan changes to a variable interest rate for the remainder of the term.
Pros of adjustable-rate mortgages
- Lower fixed rate in the first few years of homeownership
- Can save a substantial amount of money on interest payments
Cons of adjustable-rate mortgages
- Monthly mortgage payments could become unaffordable, resulting in a loan default
- Home values may fall in a few years, making it harder to refinance or sell before the loan resets
Before moving forward with any mortgage, carefully consider your financial situation. Review your circumstances and needs and do your research so you know which types of mortgage loans are most likely to help you reach your goals.