MORTGAGE
What Are the Different Types of Mortgages?
What you'll learn: What the different types of mortgages are
EXPECTED READ TIME: 5 MINUTES
December 2, 2020
As you consider buying a home, it's a good idea to get an understanding of all the loan options that are available to you, how they differ, and why one might work better than another for your financial needs. While there are more than four different types of mortgages, we'll focus on the four that are the most common.
A conventional loan is a loan that isn't backed or secured by a government agency. These loans typically come in several different term options with the most popular being 15- and 30-year loans. Even though a conventional loan is not secured by the government, it can be sold to government agencies like Fannie Mae and Freddie Mac.
What are the pros of a conventional loan?
- They can be used for a primary home, second home, or investment properties.
- The majority of mortgages today are conventional mortgages.
- They offer flexible terms — often 15, 20, or 30 years.
- They may require a small down payment.
- You may be able to request an end to private mortgage insurance (PMI) once you have achieved 20% equity in your home.
What are the cons of a conventional loan?
- They may require a higher credit score than some other types of loans.
2. Jumbo Loans
Jumbo loans are loans that exceed the amount that Fannie Mae or Freddie Mac will purchase. As mentioned above, Freddie Mac and Fannie Mae are two government-sponsored entities that set the conforming credit standards and loan limits that they will purchase. Check with your loan officer to understand the current jumbo loan threshold limit and how that might affect your purchase.
With a jumbo loan, the more cash you have for a down payment and the more cash you have in reserve, the better. You will alos need a good credit score because you are borrowing above the guaranteed guidelines set by the agencies.
What are the pros of a jumbo loan?
- You have the opportunity to purchase a more expensive home with a larger loan amount — this is useful in areas that have a higher average housing prices.
What are the cons of a jumbo loan?
- They may require a larger down payment.
- They may have higher interest rates.
- There may be higher closing costs and fees.
- They may require additional assets.
- The process to secure a jumbo loan can take more time because there is more involved.
3. Government-Insured Loans
There are two main types of loans in this category — VA loans and Federal Housing Administration (FHA) Loans. VA Loans are government backed loans that offer highly competitive interest rates with little to no down payment required. FHA loans are guaranteed by the Federal Housing Administration and include mortgage insurance premium (MIP) to protect the lender.
What are the pros of a VA loan?
- They may offer better terms and interest rates.
- Typically, there is no down payment required for a VA loan.
- There is no need for either PMI or MIP.
- There are fewer closing costs associated with VA loans.
- There is no penalty for paying off VA loans early.
What are the cons of a VA loan?
- While there is no down payment required, there is a funding fee.
- The funding fees increase when you reuse VA loan benefits.
- There are higher housing standards compared to conventional loans, as the VA sets the appraisal standards.
What are the pros of FHA loans?
- There is a lower down payment necessary compared to conventional loans.
- You can have a lower credit score compared to conventional loans.
What are the cons of FHA loans?
- There may be higher total mortgage insurance costs because you may be paying the premium over a longer period of time.
- There are higher housing standards compared to conventional loans.
- They are limited to primary residences only.
- You may be paying mortgage insurance over the life of the loan without the opportunity to remove mortgage insurance once the equity in the home exceeds 20% of the original purchase price.
4. Adjustable Rate Mortgage (ARM)
A fixed rate mortgage offers stability because your interest rate and mortgage payment will stay the same over the life of the loan, while ARMs can change the interest rate over time. The type of ARM you have is reflected in the amount of time the introductory rate stays the same. For example, if you have a 5/1 ARM, the introductory rate will stay the same for five years. After five years, the rate can change each year depending on rate indexes and margins.
What are rate indexes and margins?
There are many different types of rate indexes, and your loan officer will explain which index rate is being used with your loan. Margins are percentage points above the rate index. For example, if the current rate index is 1.5% and the margin is 2.5%, your interest rate for that year would combine the two different rates to a total of 4%. Index rates can change, but your margin rate will typically stay the same over the life of the loan. Therefore, with an ARM, you are hoping that index rates drop over time and don't go up — or you'll end up paying more each month for your mortgage.
What are the pros of an ARM?
- You can likely get a lower introductory rate than conventional loans.
- The potential lower interest rate can save you money in the short term.
What are the cons of an ARM?
- You don't have the security in knowing your interest rate and mortgage payment will not increase over time.
- Rates could climb so high as to increase your mortgage payments, or the housing market could drop while your interest rates are still high.
Now that you know more about these different types of mortgages, it is important to do further research, understand what your financial needs are, and make the best decision for yourself.