Comparing Types of Mortgages

One of the things that can make the home buying process complicated is the dozens of mortgage options. It may seem like there are too many types and there is no one-size-fits-all loan. Different loan programs fit different borrower’s various needs. We’ll discuss the most common home loans and outline who they may be best suited for.

What are the different types of mortgages?

There are two main categories of mortgages:

• Conventional
• Government

Conventional loans are either conforming or non-conforming loans. The difference between the two types is the amount you can borrow. For 2023, most of the continental U.S. has a conforming limit of $726,200 for one-unit properties. In high-cost areas, that limit is increased to $1,089,300. Anything over those limits would be considered a non-conforming loan — also known as a jumbo loan.

A conventional mortgage is not guaranteed by a government entity like the Veterans Administration (VA) or the Federal Housing Administration (FHA). A conventional mortgage is available through private lenders like PenFed and may be sold to a government-sponsored enterprise such as Fannie Mae or Freddie Mac.

Government guaranteed loans include VA and FHA loans. Both the VA and FHA work hard to provide borrowers with low down payment options so that individuals and families can fulfill their dreams of homeownership.

Like conventional home loans, government loans have their own rules. Here is some useful information that illustrates some of the differences between conventional loans and government loans:

Conventional Loans: Conforming

• Eligible Borrowers: U.S. citizens and permanent resident aliens
• One-Unit Loan Limit: 2023 conforming amounts are $726,200 or $1,089,300 (in high-cost areas)
• Number of Units: 1-4
• Minimum Down Payment: 3-5%
• Minimum Credit Score: 620 or 700+ for better rates
• Best For: Good credit and larger down payments of 20% or more
• Occupancy: Primary, second home, investment property
• Pros: 20% down payment and no *private mortgage insurance (PMI)
• Cons: Stricter credit

Conventional Loans: Jumbo

• Eligible Borrowers: U.S. citizens and permanent resident aliens
• One-Unit Loan Limit: Up to $1,000,000 (super jumbo loans up to $5,000,000 and may vary by lender)
• Number of Units: 1-4 (may vary by lender)
• Minimum Down Payment: 20-25%
• Minimum Credit Score: 700 (may vary by lender)
• Best For: Loans over conforming amounts
• Occupancy: Primary, second home
• Pros: Higher loan limits
• Cons: Stricter guidelines

Government Loans: VA

• Eligible Borrowers: Veterans, service members, and surviving spouses
• One-Unit Loan Limit: No limits (may vary based on available entitlement and lender guidelines, must qualify for VA loans)
• Number of Units: 1-4 (must live in one unit as the primary residence)
• Minimum Down Payment: 0%
• Minimum Credit Score: 580-620 (may vary by lender)
• Best For: Veterans and service members for their primary residence
• Occupancy: Primary, possible refinance on a second home, rental
• Pros: Zero to low down and typically lower rates
• Cons: Only available to veterans, service members, or their surviving spouses

Government Loans: FHA

• Eligible Borrowers: U.S. citizens and permanent resident aliens
• One-Unit Loan Limit: 2023 FHA loan limits are $472,030 or $1,089,300 (in high-cost areas)
• Number of Units: 1-4 (must live in one unit as the primary residence)
• Minimum Down Payment: 3-5%
• Minimum Credit Score: 580 (requires higher down payment)
• Best For: Low credit scores and for primary residences
• Occupancy Primary
• Pros: Low down, lower credit scores
• Cons: *Mortgage insurance premium (MIP) for the life of the loan if less than 10% down and MIP for 11 years if 10% or more down

*Private mortgage insurance (PMI) is insurance that insures the lender in case of default. It's different from homeowners' insurance. PMI is required on conventional loans with less than a 20% down payment. PMI can add $100-200 — or more — to your mortgage payment each month. The good news is that once you have 20% equity in your home, you can ask the lender to remove the PMI.

*Mortgage insurance premium (MIP) is required with FHA loans for all loans regardless of the down payment. The MIP remains for the life of the loan and can add $100-200 — or more —each month to your payment. So, when comparing conventional and FHA loans, make sure you consider the additional mortgage insurance. Even though FHA rates might be lower, the MIP can make the payment higher.

From looking at the chart above, you'll be able to see what type of home loan might be best for your circumstances.

What kind of mortgage is best for me?

Veteran: Unless you're looking at purchasing an investment property, VA loans might be a good option. When you start considering finance options, look at VA mortgages first.

Low Credit Score: The FHA offers mortgages to borrowers with credit scores of 580 or lower with a higher down payment. Plus, you won't have the extra expense of MIP.

Small Down Payment: VA loans have the lowest. Qualifying veterans can get into a home with no money down. If your credit is good, you can also consider a conventional loan that only requires between 3-5% down. Another advantage with a conventional mortgage is that you can have the PMI removed once you have 20% equity in the home.

Investment Property: You'll probably need a conventional loan. The government aims to help borrowers get into a home to live in, not build their investment portfolio. Reference the above chart for the number of acceptable units.

More Than One Unit: You'll most likely have to go the route of a conventional loan, unless you're going to live in one of the units as your primary residence. In that case, you may be able to do a VA (if you're a veteran), FHA, or conventional loan.

More About Conventional Loans

Requirements for conventional home loans can vary from lender to lender, but most want a credit score of 620. With a much higher score of 700 or more, your interest rate should be better.

Traditionally, conventional loans require 20% down. But that is changing. Now some loans require as little as 3-5% down. With the low down payment requirement, you'll also have PMI that will increase your payment. An advantage of a conventional loan over an FHA is that once you have 20% equity in your home, you can request to have the PMI removed.

Credit score requirements and interest rates can vary between conforming loans (under $726,200) and non-conforming (over $726,200 or $1,089,300 for high-cost areas). Non-conforming jumbo loans require a larger down payment, have stricter credit requirements, and may also have higher interest rates.

More About Conventional Jumbo Loans

A jumbo loan is a non-conforming mortgage because it exceeds the conforming loan limit. For 2023, that limit in most of the U.S. is $726,200 or $1,089,300 for high-cost areas. Jumbo loans can be harder to get because there is more risk for the lender. Also, because a jumbo loan exceeds the Federal Housing Finance Agency (FHFA), it cannot be purchased by either Freddie Mac or Fannie Mae. Instead, private investors buy these loans.

Jumbo loans are mainly for larger homes and vacation properties. If your credit is less than stellar and you don't have a large down payment, you may not qualify for a conventional jumbo loan.

More About Government Home Loans

Loans backed by government entities such as VA and FHA are meant to assist low to middle-income families achieve their dream of buying a home. Let's take a more in-depth look at VA and FHA mortgages.

What is a VA loan?

The Veterans Administration guarantees VA loans. They offer highly competitive interest rates and there is little to no down payment required.

There are some great benefits to a VA loan if you qualify. You can typically purchase a home with less money out-of-pocket with the down payment being zero or very low. You will need to obtain your Certificate of Eligibility (COE) to get started.

Primary residences, second homes, and investment properties are eligible for an Interest Rate Reduction Refinance Loan (IRRRL). VA-guaranteed loans for second homes and investment properties are only eligible as IRRRL transactions. The borrower will need to certify that they previously occupied the property as their primary residence.

What is an FHA loan?

An FHA loan is issued by an approved lender and backed by the Federal Housing Administration (FHA). Since this is another type of government-backed loan, like a VA loan, there is typically a smaller down payment required. These mortgages are meant for low to middle-income families to assist in their home purchase.

There are lending limits for FHA home loans. For 2023, it is $726,200. In high-cost areas like California, New York, and Hawaii, that limit may be up to $1,089,300. The FHA has a map that shows the county lending limits. Also, credit score requirements are less strict than with conventional loans.

What is a fixed-rate mortgage?

With a fixed-rate mortgage, the interest rate stays the same over the loan's life (or term). Let's say you have a 30-year fixed loan. That means your interest rate is locked in and will not change for the full 30-year period.

Fixed-rate mortgages are best suited for someone who likes security. With a fixed rate, their interest rate can never increase. If mortgage rates are historically low — as they are in 2020 — then a fixed-rate mortgage is a smart financial decision.

What is an adjustable-rate mortgage?

An adjustable-rate mortgage (ARM) is also called a variable rate. Unlike a fixed rate, the interest rate changes after the introductory period of 3-10 years.

ARMs can be appealing to borrowers when the introductory rate is lower than the current fixed rates. That's especially the case with jumbo loans. But when overall rates are extremely low, ARM rates may be higher. It depends on the market.

Consider Terms for Mortgages

The term (length) of your mortgage loan is how long you will have to pay it off. The most common terms for fixed-rate loans are 15-, 20-, and 30-years. The term for ARMs is typically 30 years with the initial term before rate adjustment being either 3-, 5-, 7-, or 10-years.