If you’ve started looking into the home buying process, you have probably discovered the myriad of mortgage options available. Even worse, mortgage types tend to change yearly, leaving many would-be homeowners more lost and confused about what type of mortgage may be best for them. If you’re struggling with what type of mortgage to get, this 2020 guide is here for you.
Before we get too far into various types of mortgages, let’s discuss the most two most common you will hear about:
Different Types of Mortgages
Fixed Rate vs Adjustable Rate
When looking at mortgages, the first choice to make will be what type of mortgage rate you are wanting, or able, to pay. Any type of mortgage you apply for will fall into one of these two categories. Let’s discuss these in more detail:
- Fixed-Rate Mortgages: These mortgage loans have a fixed (meaning the interest rate does not change) throughout the entire loan. This means that your monthly mortgage payments are predictable, and will not fluctuate with interest rates. The down-side to this stability, is you may end up paying higher interest rates over the life of the loan.
- Adjustable-Rate Mortgages: These mortgages (also known as ARMs) have an interest rate that will fluctuate, generally yearly. Adjustable-Rate Mortgages tend to have an introductory interest period where the rate of the loan may be lower and fixed for 3-5 years. Once the initial loan period is over, the interest rate will be adjusted, and depending on the economy, it may end up being higher than you would have had under a fixed-rate mortgage. The type of Adjustable-Rate Mortgage you have can also be called a hybrid. For example, a 5/1 ARM loan is considered hybrid because the interest rate stays the same for the first 5 years and adjusts every year after.
Government Insured vs Convention Mortgage Loans
The next thing you will need to consider is whether or not to get what’s called “Government Insured” loan vs a Conventional Mortgage Loan. Conventional mortgages are basically your regular type of mortgage loan. These are not guaranteed by the government in any way, so banks can set their own standards that customers need to meet in order to qualify, and set their own interest rates.
The government-insured loan includes loan types such as FHA or VA loans and is government-backed, but sometimes require you to meet specific criteria in order to qualify. Government-backed loans are as follows:
- FHA Loans: These are available to all-types of home-buyers (First or second time) and are managed by the Department of Housing and Urban Development (HUD – who also offer HUD Homes). With these loan types, the government offers the lender insurance against losses if the buyer defaults and doesn’t pay the loan. The advantage to homebuyers is that down payments can be as low as 3.5%. The disadvantage is that you have to pay PMI, or mortgage insurance which is added on to your monthly mortgage payment.
- VA Loans: VA loans are from the U.S. Department of Veteran Affairs. This loan type is only available to military service members and their immediate families. These loans are also insured by the government, which helps protect the bank from loss. The benefit to VA Loan borrowers is that the borrower receives 100% financing for the purchase of the home, which means there is no down-payment requirement.
- USDA Loans: These loans are offered by the United States Department of Agriculture (USDA) and are meant for homebuyers in more rural areas who also meet specific income requirements, such as a steady, low or modest income and generally are unable to qualify for traditional financing.
The next option is Jumbo vs Conforming Loans
This refers to the size of the loan. If you are trying to borrow above a certain amount, you will have to apply for a Jumbo loan for example.
- Conforming Loan: This type of loan meets specific underwriting guidelines of the two government-controlled corporations responsible for lending, Fannie Mae or Freddie Mac. If you’ve ever watched The Wolf of Wall Street, these names will sound familiar. These corporations purchase loans from lenders, and then sell them to Wall Street. A “Conforming Loan” conforms to pre-existing criteria, such as loan size.
- Jumbo Loan: This type of loan exceeds the loan criteria set by Fannie Mae or Freddie Mac, and as such represents a higher risk to the lender. This means that borrowers of Jumbo Loans generally will need excellent credit scores and the ability to provide larger down-payments. These types of loans may also have higher interest rates than their counterparts.
Which Loan is Right for You?
Determining which of these mortgage loans are right for you will depend on your specific circumstances. You want to consider:
- Your credit history
- Your current income
- The amount you can pay for a down payment (20% is generally the best as this helps avoid insurance)
- Any past military history of yourself or family members
- The type of home and size of loan needed.
- How long you intend to live in the home and maintain the loan.
Other non-traditional types of mortgages not mentioned above, such as rent-to-own homes may also be an option to consider. Learn more about what a rent-to-own home is to familiarize yourself with this option and browse rent-to-own home listings or HUD home listings near you.