Buying a home is exciting, but figuring out the financing
side of things can feel overwhelming. Chin up: Choosing among the different
types of mortgage loans isn?t all that painful if you know the lingo. Once
you?ve done some homework and nailed down a budget and down payment amount, and
you?ve reviewed your credit, you?ll have a better idea of what loan works best
for your needs.
Here?s a primer on some of the most common types of
mortgages.
1. Conventional mortgages
2. Jumbo mortgages
3. Government-insured mortgages
4. Fixed-rate mortgages
5. Adjustable-rate mortgages
1. Conventional mortgages
A conventional mortgage is a home loan that?s not insured by
the federal government. There are two types of conventional loans: conforming
and non-conforming loans.
A conforming loan simply means the loan amount falls within
maximum limits set by Fannie Mae or Freddie Mac, the government-sponsored
enterprises (GSEs) that back most U.S. mortgages. The types of mortgage loans
that don?t meet these guidelines are considered non-conforming loans. Jumbo
loans, which represent large mortgages above the limits set by Fannie and
Freddie for different counties, are the most common type of non-conforming
loan.
Generally, lenders require you to pay private mortgage
insurance 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
You can ask your lender to cancel PMI once you?ve gained 20
percent equity
You can pay as little as 3 percent down for loans backed by
Fannie Mae or Freddie Mac
Cons of conventional mortgages
Minimum FICO score of 620 or higher is often required
You must have a debt-to-income ratio of 45 percent to 50
percent
Likely must 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
Who should get one?
Conventional loans are ideal for borrowers with strong
credit, a stable income and employment history, and a down payment of at least
3 percent.
2. Jumbo mortgages
Jumbo mortgages are conventional types of mortgages that
have non-conforming loan limits. This means the home price exceeds federal loan
limits. For 2020, the maximum conforming loan limit for single-family homes in
most of the U.S. is $510,400. In certain high-cost areas, the ceiling is
$765,600. Jumbo loans are more common in higher-cost areas, and generally
require more in-depth documentation to qualify.
Pros of jumbo mortgages
You 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 is needed
A FICO score of 700 or higher typically is required,
although some lenders will accept a minimum score of 660
You cannot have a debt-to-income ratio above 45 percent
Must show you have significant assets (generally 10 percent
of the loan amount) in cash or savings accounts
Who should get one?
Jumbo loans make sense for more affluent buyers purchasing a
high-end home. Jumbo borrowers should have good to excellent credit, a high
income and a substantial down payment. Many reputable lenders offer jumbo loans
at competitive rates.
You can use Bankrate?s calculator to determine how much you
can afford to spend on a home.
3. Government-insured mortgages
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 and 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. This 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 PMI, 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
They help you finance a home when you don?t qualify for a
conventional loan
Credit requirements are more relaxed
You don?t need a large down payment
They?re open to repeat and first-time buyers
Cons of government-insured loans
Expect to pay mandatory mortgage insurance premiums that
cannot be canceled on some loans
You?ll have higher overall borrowing costs
Expect to provide more documentation, depending on the loan
type, to prove eligibility
Who should get one?
Government-insured loans are ideal if you have low cash
savings, less-than-stellar credit and can?t qualify for a conventional loan. VA
loans tend to offer the best terms and most flexibility compared to other loan
types for military borrowers.
4. Fixed-rate mortgages
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
Your monthly principal and interest payments stay the same
throughout the life of the loan
You can more precisely budget other expenses month to month
Cons of fixed-rate mortgages
You?ll generally pay more interest with a longer-term loan
It takes longer to build equity in your home.
Interest rates typically are higher than rates on
adjustable-rate mortgages
Who should get one?
If you plan to stay in your home for at least seven to 10
years, a fixed-rate mortgage offers stability with your monthly payments.
5. Adjustable-rate mortgages
Unlike the stability of fixed-rate loans, adjustable-rate
mortgages (ARMs) 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. Look for an ARM that caps how much your interest rate or monthly mortgage
rate can increase so you don?t wind up in financial trouble when the loan
resets.
Pros of adjustable-rate mortgages
You?ll enjoy a lower fixed rate in the first few years of
homeownership
You?ll save a substantial amount of money on interest
payments
Cons of adjustable-rate mortgages
Your 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 your home before the loan resets
Who should get one?
You must be comfortable with a certain level of risk before
getting an ARM. If you don?t plan to stay in your home beyond a few years, an
ARM could save you big on interest
payments.
Other types of home loans
In addition to these common kinds of mortgages, there are
other types you may find when shopping around for a loan. These include:
Construction loans: If you want to build a home, a
construction loan can be a good choice. You can decide whether to get a
separate construction loan for the project and then a separate mortgage to pay
it off, or wrap the two together. In general, you need a higher down payment
for a construction loan and proof that you can afford it.
Interest-only mortgages: With an interest-only mortgage, the
borrower pays only the interest on the loan for a set period of time. After
that time period is over, usually between five and seven years, your monthly
payment increases as you begin paying your principal. With this type of loan,
you won?t build equity as quickly, since you?re initially only paying interest.
These loans are best for those who know they can sell or refinance, or for
those who can reasonably expect to afford the higher monthly payment later.
Balloon mortgages: Another type of home loan you may come
across is a balloon mortgage, which requires a large payment at the end of the
loan term. Generally, you?ll make payments based on a 30-year term, but only
for a short time, such as seven years. At the end of that time, you?ll make a
large payment on the outstanding balance, which can be unmanageable if you?re
not prepared. You can use the balloon mortgage calculator to see if this kind
of loan makes sense for you.
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.
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