Exploring the different types of home mortgage loans available will present you with a wide array of products, terms and options. There are important differences to understand and consider in each of these areas and it can get complex and complicated. It’s a good idea therefore to start with the basics. When looking for a first mortgage loan, there are generally two major types or categories: Government loans or Conventional loans.
- Government loans, or non-conventional loans, are mortgages that are insured or backed by the government, most commonly either the FHA (Federal Housing Authority) or the VA (Veteran’s Administration). When you obtain either an FHA or VA loan, the lender, or mortgage holder, has insurance through that agency that if you are unable to pay back the loan, they will step and cover the loss, if any. By design, to enable a wider range of people to be homeowner’s, a government insured loan is typically easier to qualify for and down payment amounts are lower.
- Conventional loans are, in short, all other types of non-government insured or backed mortgage loans. The lender assumes the payback risk, therefore the qualification standards are more stringent and the down payment amounts are higher. Private mortgage insurance is often required for loans that have down payments less than 20%.
Most standard first mortgage conventional loans offered by lenders or banks will follow loan guidelines that are set by the quasi-government entities — the Federal National Mortgage Association (Fannie Mae) and/or the Federal Home Loan Mortgage Corporation (Freddie Mac). This allows for conformity in the conventional mortgage market. Broadly speaking, conventional loans will require you to have good credit, a steady, consistent and documented income, and a down payment of at least 20% of the loan amount. If you have less than the 20%, you will likely need to pay for PMI (Private Mortgage Insurance) which serves to minimize the loss risk to the lender if you are unable to repay the mortgage.
A government, non-conventional loan is usually easier to qualify, requires decent or average credit and is a little less stringent on income requirements. The FHA down payment amount is usually 3.5% of the loan amount and there are even some programs where no down payment is required. There are loan balance limits and in almost all cases there is a mortgage insurance premium amount factored into the loan payment. The approval process does take a bit longer too as there are more steps the process versus a conventional loan.
Some common government or non-conventional loans include:
- FHA loans, insured by the Federal Housing Administration is just about available to everyone who can qualify. The FHA loan requirement guidelines for loan qualification are the most flexible of all mortgage loans, so first time homebuyers can qualify to get a loan. With a FHA loan too, part of the loan’s closing costs can be included in the loan amount rather than having to come up with that much more money at this time of the closing.
- VA (Veterans Administration) loans are for specifically for active duty or retired, service members. Under certain criteria, spouses and widows/widowers of service members are eligible too. VA loans do not require down payments and there is no additional costs for mortgage insurance. For this type of loan, there are though unique fees such as a VA funding fee.
- USDA (US Department of Agriculture) loans are available for borrowers in rural or suburban areas. These loans come from the USDA Rural Development Guaranteed Housing Loan Program. Like other government loans, they have low or no down payment options, lower interest rates, and do require mortgage insurance.
All of the government-backed loans have their own specific requirements. VA loans may depend on the length of one’s military service, or when s/he served. USDA loans are limited to people with a demonstrated need, and may exclude metropolitan areas.
Beyond these two primary types of loans types, there are also generally two (2) types of interest rate structures, a Fixed rate loan and an Adjustable rate loan.
- Fixed-rate mortgages carry one fixed rate for the life of the loan. If you borrow today at 6%, you will always pay 6% interest until the loan is repaid in full.
- Adjustable-rate mortgages, also commonly referred to as “ARMs” have interest rates that change over time. The rates can change once per year, or any interval from 6 months to 10 years. Each loan will have a specific term. Some ARM loans specify an introductory period during which the rate won’t change. A 7/1 ARM will have the same rate for the first seven years, then adjust every year thereafter.
The amount by which your ARM rate will adjust depends on market conditions and which market index the rate is set from. There are usually caps or limits on how much a rate can change during any adjustment period, however ARMs do carry an added risk as you just don’t know the exact amounts until 45-60 days before the adjustment is made. A fixed rate mortgage lets you plan further ahead, knowing what your mortgage payment will be for the foreseeable future.
Choosing between a fixed or adjustable rate mortgage does require a strong financial analysis and there are various qualification requirements depending on the type you want. First-time home buyers should get pre-purchase education so they understand the full choices available to them.
Other kinds of home loans:
- Balloon loans include a “balloon payment” at some point during the loan. The mortgage payments might be much lower, or they might include interest-only payments for a time. Then, usually at the end of the loan, the remaining balance will be due all at once. For example, you might make a much smaller loan payment for 7 years, after which the remaining balance is due. So if you paid $50,000 over that time toward a total debt of $200,000, you will owe the remaining lump sum of $150,000 at the 7-year mark. People who get balloon mortgages typically intend to sell the property or refinance before the balloon payment comes due.
- Combo loans combine multiple mortgages, a first and a second mortgage simultaneously, where you would get one loan, the first, at 80% of the home’s value and another, second loan at 15% of the value. This type of loan helps when your down payment is less than 20%, in this case 5% and helps you avoid the need for mortgage insurance. The second loan typically carries a higher interest rate, so it’s usually only a good idea if the combined total payment is still less than paying PMI on the primary mortgage. The two mortgages in a combo loan can be fixed, adjustable, or one of each.
- Improvement loans, or “K” loans, allow the borrower to renovate a property that is in disrepair. An FHA 203K loan is the most common loan of this type. Because it is FHA insured, lenders are more likely to offer funding, even if the house is not in good condition. There are extensive rules on this type of loan, such as repaired and in living condition within six months. The loan can include the mortgage and renovation loan, or just be for home improvement expenses.
- Bridge loans combine one’s current mortgage with the new property they are buying. This allows a seller to buy a new home and move, then sell the previous property and repay the bridge loan. These are also called swing loans.
- Equity loans are made after a homeowner has purchased a home and built up equity. This loan is backed by the equity in the home, so failure to pay can lead to foreclosure on the property. An equity loan can be fixed or adjustable, and may be established as a revolving line of credit from which the homeowner can withdraw funds.
- Reverse mortgages are for homeowners over age 62. After years of building equity, a reverse mortgage gives the homeowner monthly payments from the lender for the rest of his/her life, as long as s/he lives in the home. When the homeowner moves out or passes away, the lender takes ownership of the property.
There is one more loan distinction you may hear about that is not as common: Conforming vs. Jumbo.
A conforming loan means the loan conforms to Fannie Mae and Freddie Mac guidelines, while a jumbo loan is too large to conform to those loan limits. The specific amount that makes a loan go from conforming to jumbo depends on the local market. Jumbo loans will be more expensive and harder to qualify for since they are not government backed or easily sold to other financial institutions. Borrowers might get a combo loan in order to get their first mortgage down to conforming size, or make a large down payment to avoid ending up with a jumbo loan.
We know there is a lot to think about when getting a home loan, and the different choices available can be confusing. A HUD-approved housing counseling agency can offer First-Time Home Buyer coaching that will help inform you on these and many other helpful homeownership details. We think it’s essential for first time homebuyers to take advantage of this education, because buying a home is most likely the largest purchase one will ever make. Take the extra time to learn all about the process and all of your options.