5 Different Types of Mortgage Loans For Home Buyers

A new home may be one of the biggest purchases you’ll make in your life. Unless you can buy your new home entirely in cash, finding the right property is only half the battle. The other half is choosing the best type of mortgage loan. When you borrow money from a lender, you’re making a legal agreement to repay that loan over a set amount of time (albeit with interest). Your loan choice is a decision that will have financial consequences for the next 15 or 30 years. 

Use this guide to learn more about each mortgage type and how they might work for you.

Types of Mortgages

1. Conventional loan 

Best for borrowers with a good credit score. It is the most common type of mortgage and refers to any mortgage not backed by a government agency. And it comes in two forms:

Conforming loans – it “conforms” to the set of standards put in place by the Federal Housing Finance Agency (FHFA), which includes credit, debt, and loan size. 

Non-conforming loans – These loans do not meet FHFA standards. Instead, they cater to borrowers looking to purchase more-expensive homes or individuals with unusual credit profiles. 

2. Jumbo loan

Jumbo mortgages are home loan products that fall outside FHFA borrowing limits. Jumbo loans are more common in higher-cost areas such as Los Angeles, San Francisco, New York City, and the state of Hawaii, where home prices are often on the higher end. This type of loan is riskier to a lender, so borrowers typically must show larger cash reserves, make a down payment of 10% to 20% (or more), and have strong credit. 

3. Government-insured loan

There are a number of government-insured loans that can make homebuying more accessible. You may have heard of VA, USDA, or FHA loans, all of which make it easier for some borrowers to qualify for and afford a mortgage. The U.S. government isn’t a mortgage lender, but it does play a role in making homeownership accessible to more Americans. Three government agencies back mortgages: the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA), and the U.S. Department of Veterans Affairs (VA).

• VA loans – VA helps Servicemembers, Veterans, and eligible surviving spouses become homeowners. VA loans provide flexible, low-interest mortgages. There’s no minimum down payment, mortgage insurance, or credit score requirement, and limited closing costs. 

• USDA loans – USDA believes that helping families in rural areas become homeowners creates strong communities and a better quality of life. USDA loans help moderate- to low-income borrowers who meet certain income limits buy homes in rural, USDA-eligible areas. Some USDA loans do not require a down payment for eligible borrowers. There are extra fees, though, including an upfront fee of 1 percent of the loan amount (which can typically be financed with the loan) and an annual fee. 

• FHA loans – These home loans come with competitive interest rates and help make homeownership possible for borrowers without a large down payment or pristine credit. An FHA loan is a type of government-backed mortgage loan that can allow you to buy a home with looser financial requirements. You may qualify for an FHA loan if you have debt or a lower credit score. You might even be able to get an FHA loan with a bankruptcy or other financial issue on your record. FHA loans require two mortgage insurance premiums, which can increase the overall cost of your mortgage. Lastly, with an FHA loan, the home seller is allowed to contribute to closing costs. 

4. Fixed-rate mortgage

Mortgage terms, including the length of repayment, are a key factor in how a lender prices your loan and your interest rate. It maintains the same interest rate over the life of your loan, which means your monthly mortgage payment always stays the same. If you want to pay off your home faster and can afford a higher monthly payment, a shorter-term fixed-rate loan (say 15 or 20 years) helps you shave off time and interest payments. You'll also build equity in your home much faster. Opting for a shorter fixed-term mortgage means monthly payments will be higher than with a longer-term loan. 

5. Adjustable-rate mortgage (ARM)

Unlike the stability of fixed-rate loans, adjustable-rate mortgages (ARMs) have interest rates that fluctuate with market conditions. These loans can be risky if you’re unable to pay a higher monthly mortgage payment once the rate resets. 

ARMs are a solid option if you don't plan to stay in a home beyond the initial fixed-rate period or know that you intend to refinance before the loan resets. Because interest rates for ARMs tend to be lower than fixed rates in the early years of repayment, so you could potentially save thousands of dollars on interest payments in the initial years of homeownership.

Other Types of Home Loans

In addition to these common kinds of mortgages, there are other types of mortgages that are less popular, but still available to buyers that you may find when shopping around for a loan:

• Construction loans – Is a short-term loan that covers only the costs of custom home building. This is different from a mortgage, and it’s considered specialty financing. Once the home is built, the prospective occupant must apply for a mortgage to pay for the completed home. So, you can decide whether to get a separate construction loan for the project and a separate mortgage to pay it off. A construction-to-permanent loan, which merges construction costs and financing into a single loan product, is also an option. Both options typically require a higher down payment and proof that you can afford the monthly payments.

• Interest-only mortgages – With an interest-only mortgage, the borrower makes interest-only payments for a set period – usually between five and seven years- followed by payments for both principal and interest. You have the option of making principal payments during your interest-only payment term, but once the interest-only period ends, both interest and principal payments are required. Still, 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.

• Piggyback loans – If you’re looking for a home but it’s out of your price range—particularly in markets where housing prices are skyrocketing—using a piggyback loan can help ease upfront costs. A piggyback loan is actually a second loan after the first mortgage used to finance one property. It’s typically used to lower initial mortgage costs like a down payment or private mortgage insurance, which many lenders require on the first mortgage.

• Balloon mortgages – A balloon mortgage comes with a major risk for both the borrower and the mortgage lender, but it can be advantageous in some circumstances. A balloon mortgage is a type of home loan in which you make low or no monthly payments for a short term, usually five or seven years. These initial payments might go solely to interest or to both interest and the loan principal, depending on how the mortgage is structured. After this low- or no-payment period, you make a lump sum payment — known as a balloon payment — for the balance in full. This balloon payment can be thousands or tens of thousands of dollars, and generally more than two times the monthly payment, according to the Consumer Financial Protection Bureau. This type of loan can be ideal for house flippers, who can use the proceeds from the sale of the home to make the balloon payment. 

The right type of mortgage is a decision that will stay with you (and your wallet) for a very long time. Start by understanding your needs (what you can afford, and how long you plan to stay in the home) and then choose the loan that fits you best. And now that you have an idea of the right kind of loan for your home purchase, it’s time to find the right mortgage lender to make it happen. Every lender is different, and it’s important to compare shops to find the best terms that fit your finances. 

Sources: 

https://www.bankrate.com/
https://time.com/nextadvisor/
https://www.investopedia.com/
https://www.chase.com/
https://www.forbes.com/advisor/
https://www.rocketmortgage.com/