9 Types Of Home Loans: Which Option Works Best For You?
10-Minute ReadApril 05, 2021
At a certain point in your mortgage application process, you’ll need to select a type of home loan to finance your purchase or refinance. But which option will work best for you? That depends on the kind of borrower you are.
In this article, we’ll explore the different types of home loans to help you determine which solution is the right fit. Let’s take a closer look.
Common Types Of Mortgage Loans
Understanding the different mortgage options begins with understanding the most common kinds of home loans that you’ll encounter during your search. The type of mortgage you choose refers to the categories that separate one home loan option from another – everything from the type of borrower who qualifies to the interest rate you can expect.
Listed below are some of the most popular types of home loans that are worth your consideration.
1. Conventional Mortgages
True to its name, the conventional mortgage is the most standard home loan and the preferred option for many buyers and refinancers. In simplest terms, a conventional mortgage is a type of home loan that is not backed by a government agency.
Because they are available through private lenders and are not insured by federal agencies, conventional home loans tend to have higher qualifications for an applicant’s credit history, debt-to-income ratio (DTI) and assets. In most cases, you’ll need a minimum credit score of 620, although borrowers with higher scores are usually rewarded with lower interest rates. Most lenders will require a DTI no greater than 50%.
A majority of conventional mortgages are conforming loans, which means they meet the basic qualifications for a purchase from Fannie Mae or Freddie Mac. Both of these government-sponsored enterprises purchase mortgages from lenders and sell them back to real estate investors. As such, conforming loans follow similar standards that conventional lenders set, including credit scores above 620 and zero backing from the government.
The Advantages Of Conventional Mortgages
- Down payments are as low as 3%.
- Borrowers can finance primary homes, second homes or investment properties.
- Conventional loans can have lower interest rates compared to other popular options.
The Disadvantages Of Conventional Mortgages
- Private mortgage insurance is required for down payments less than 20%.
- Lenders usually require a minimum credit score of 620.
- DTI must be lower than 50%.
Get the right home loan for you.
2. FHA Loans
Backed by the Federal Housing Administration, FHA loans are a type of mortgage with less stringent requirements than conventional loans. The FHA insures lenders against defaulted payments, which in turn means that lenders can offer borrowers lower interest rates and accept applicants with lower credit scores.
You’ll usually need a credit score greater than 580 to be eligible for an FHA loan, but you could still be approved with a score as low as 500, so long as you have at least a 10% down payment. If you are at or above 580, however, you could be able to borrow with as little as 3.5% down.
FHA loans may be easier for most buyers to qualify for, but they come with their own list of requirements you’ll need to keep in mind. You’ll need an FHA-certified home appraisal before you can fully qualify, and the home will need to be inspected to meet certain regulations and standards. At the start of your loan and for each month, you’ll also have to pay a Mortgage Insurance Premium, which helps protect your lender in the event that you default on your loan. If your down payment is 10% or greater, you’ll only have to pay for 11 years. Otherwise, you should expect to pay insurance for the lifespan of your FHA loan.
The Advantages Of FHA Loans
- Lenders accept credit scores in the 500s.
- Opportunities to reduce the down payment help mitigate upfront costs.
- FHA loans are more lenient with financial roadblocks like bankruptcy.
The Disadvantages Of FHA Loans
- The seller may refuse to accept an FHA loan.
- FHA loans are only intended to finance your primary residence.
- Housing restrictions could limit your choices if the house you are purchasing does not pass the government’s health and safety standards.
3. USDA Loans
Next comes another type of government-backed mortgage – the USDA home loan. If you’re looking for a modern home in a booming metropolis, then there’s a good chance this option isn’t for you. The United States Department of Agriculture restricts this kind of mortgage to residents in rural communities in an effort to encourage development in low-population areas.
With that in mind, USDA loans unsurprisingly require applicants to meet criteria based on their location and income level. If you’re sold on this type of loan, you’ll first have to find homes for sale that meet the USDA’s parameters. You also become ineligible if your household income exceeds 115% of the median income in your community.
One of the most persuasive features of USDA loans for borrowers is their lack of down payment requirements. This makes USDA mortgages even more appealing to low- and moderate-income households, who may not have the cash on-hand to put money down on closing day.
The Advantages Of USDA Loans
- USDA loan lenders accept credit scores as low as 640.
- Income thresholds help make homeownership accessible to those with lower incomes.
- USDA loan recipients are sometimes able to roll their closing costs into the loan itself.
The Disadvantages Of USDA Loans
- Eligibility is restricted to rural and suburban areas.
- Home appraisals are required to verify that the home meets USDA standards.
- The home you’re financing must be your primary residence.
4. VA Loans
Rounding out the government-insured mortgages on this list is the VA loan. VA loans are exclusive to active members of the military, veterans and surviving spouses. The VA itself does not issue VA loans, but they are in charge of determining who qualifies for the loan and which lenders can provide it.
VA loans are an ideal mortgage for qualified individuals who can’t secure home loans with tighter restrictions surrounding their credit scores, DTIs and minimum down payments.
If you’re considering a VA loan for your next purchase or refinance, you’ll need to keep a few important requirements in mind. First, you’ll have to obtain a Certificate of Eligibility (COE), which is a document that verifies your previous or current military status and certifies that you are an eligible candidate for the loan. There’s a good chance you’ll also be responsible for paying a VA funding fee – in addition to other closing costs. This money helps fund the VA’s housing efforts for future military members.
The Advantages Of VA Loans
- VA loans do not have down payment requirements.
- Borrowers are not obligated to purchase private mortgage insurance.
- Lenders can approve applicants with DTIs as high as 60%.
The Disadvantages Of VA Loans
- Most VA loan recipients pay a VA loan funding fee.
- Closing costs are not a covered expense.
- Eligibility is limited to active military members, veterans and surviving spouses who meet the VA’s guidelines.
5. Jumbo Loans
Sometimes, buying the home of your dreams might require a high-value mortgage if the property is expensive. This is where jumbo loans come into play. Jumbo mortgages are loans that surpass the limits set by the Federal Housing Financing Agency. Breaching this limit means that jumbo mortgages do not conform to the standards set by Fannie Mae or Freddie Mac, which is why they are considered nonconforming loans.
But what exactly does that mean for you? Lenders often take on a much higher level of risk when they approve an applicant for a jumbo loan, which can result in higher interest rates and down payments as high as 20%. Your credit score is once again a significant determinant of your eligibility, and you’ll typically need to see a score of at least a 700 on your credit report.
On top of these rigorous guidelines, jumbo loans come with plenty of additional stipulations for applicants that impact how much money you’ll need to buy the house. Lenders might request additional proof that you have the funds necessary to pay back your sizable loan, and your total bill for closing costs could be much higher when compared to other loan types.
The Advantages Of Jumbo Loans
- Borrowers can use jumbo loans to finance primary and secondary households.
- Jumbo mortgages help finance homes with mortgages that exceed conforming loan regulations.
- Although interest rates are higher, they are usually still competitive with the current rates on the market.
The Disadvantages Of Jumbo Loans
- Most lenders like to see that you have cash on reserve as proof of funds.
- Down payments are as high as 20%.
- Closing costs are more expensive than the typical 3% – 6%.
Home Loan Options By The Type Of Rate
Once you’ve scoured through the various types of mortgages, you’ll need to settle on an interest rate type that best aligns with your repayment strategies. As a rule of thumb, the type of rate you choose will impact whether your interest rate will stay the same or fluctuate over the lifespan of the loan.
Below, you’ll find two common interest rate types available to mortgage applicants.
6. Fixed-Rate Mortgages
Up first is the fixed-rate mortgage, which describes any type of mortgage where the interest rate does not change during your repayment.
Fixed-rate mortgages are a good choice for you if you’re not looking for any surprises in your monthly mortgage bill. That’s because the total you pay on the mortgage itself – toward both the principal and interest – is fixed at a certain amount, regardless of where current interest rates stand. Other homeowner expenses, such as your property taxes or mortgage insurance, could change from month to month. But a fixed-rate mortgage will be a guaranteed constant.
The Advantages Of Fixed-Rate Mortgages
- Fixed-rate mortgages are predictable and easy to fit into a regular budget.
- Getting a fixed-rate mortgage when interest rates are low could help you save thousands over the mortgage’s lifespan.
- Fixed-rate mortgages are simple to understand, so borrowers know what they’re getting into.
The Disadvantages Of Fixed-Rate Mortgages
- Unless you refinance your home, you could be stuck paying a large amount of interest if rates have since dropped.
- Because interest is front-loaded in your payment schedule, paying off the principal takes time.
- Fixed-rate loans typically do not offer the lowest possible interest rate.
7. Adjustable-Rate Mortgages
Adjustable-rate mortgages, or ARMs, offer an interest rate that calibrates to the current market. ARMs usually include an initial period with a fixed, low interest rate, but they are liable to fluctuate higher or lower once this timeframe ends. As an example, a 10-year ARM has a fixed interest rate for the first 10 years and an adjustable rate for the remainder of the loan.
If you opt for a variable-rate home loan, you’ll need to pay attention to how frequently your interest rate updates and how much it rises or falls. Interest rates influence the total that shows up on your mortgage bill, and a spike in interest can contribute to higher home expenses for that month. You’ll also want to pay attention to the kinds of caps within your mortgage agreement. Periodic caps, for example, restrict the amount your interest rate can change over a set period of time, while a lifetime cap limits how much your rate can shift over the entire length of your loan.
As a general best practice, ARMs are typically not the best route to take when market interest rates are already low. By contrast, a fixed-rate mortgage will guarantee you keep a favorable interest rate from your first payment to your last.
The Advantages Of Adjustable-Rate Mortgages
- Homeowners who move frequently or who are buying a starter home can sell while their interest rates are still fixed.
- You could end up with lower monthly payments once your fixed-rate period has ended.
- Cap rates are attached to many types of ARMs to help limit the how much the interest rate fluctuates.
The Disadvantages Of Adjustable-Rate Mortgages
- Monthly mortgage payments can vary widely.
- Some ARMs charge prepayment penalties to borrowers who sell off the home or refinance in the early stages of your repayment.
- The discounts you might receive with an ARM usually do not outweigh the benefits of a lower fixed interest rate.
Mortgage Options By The Type Of Term
A mortgage “term” can generally refer to a word or definition associated with the mortgage process, but in this context, mortgage terms stake out the length of time you’ll have to pay off your principal and interest.
Rounding out our list are some common mortgage terms that you’ll encounter during your search for the best home loan option.
8. 30-Year Mortgages
Many borrowers might call a 30-year mortgage their top choice when it comes time to select a term length, primarily because of the lower monthly mortgage installments. A mortgage divided by 30 years of regular payments is simply more manageable than a loan due in half or a third of that time.
Spending less per month on your mortgage also opens up your budget for your other expenses, which is helpful for those who aren’t sure if they should buy a house or continue saving. Smaller payments can also help you afford a much larger home, although it’s never a good idea to venture too far outside of your budget.
Of course, additional time to pay off the loan also means extra time for interest to accumulate. You might pay in smaller portions along the way, but the total cost will be higher relative to mortgages with shorter terms.
The Advantages Of 30-Year Mortgages
- Monthly mortgage payments are lower and more affordable.
- Longer mortgage terms mean borrowers can potentially afford more property.
- Borrowers who do not have prepayment penalties baked into their mortgage agreements can pay back 30-year mortgages early and save on interest.
The Disadvantages Of 30-Year Mortgages
- You’ll pay more interest compared to short-term loans.
- Building up home equity takes a longer time.
- Low mortgage bills might tempt some borrowers to purchase homes that exceed how much they can realistically afford.
Get the right home loan for you.
9. 15-Year Mortgages
If 30-year mortgages offer low monthly payments and a larger total cost, the opposite is true for 15-year mortgages. Home loans with 15-year terms give you half as much time to pay back your loan in full, but that also means you’ll have half as much time for interest to generate on your principal balance.
For some borrowers, the spike in monthly payment requirements makes shorter-term home loans too difficult to pay back. However, those who can tackle a 15-year mortgage will enjoy a lower overall cost and the ease of mind that comes with a fully paid home.
The Advantages Of 15-Year Mortgages
- Typically, 15-year mortgages will have lower interest rates than 30-year mortgages.
- The equity you invest into your home builds quickly.
- Once paid off, you’ll have additional resources to put toward investing and saving.
The Disadvantages Of 15-Year Mortgages
- High monthly payments stack on top of the other fees you have when you buy a home.
- You could be limited in the amount of home you can afford.
- Sizable payments make investing or saving your cash difficult during repayment.
The Bottom Line
The home buying process is filled with challenging decisions, and the type of loan you choose is no exception to that rule. The kind of loan, the term length and the interest rate type all influence how you should approach paying off your home.
Regardless of the home loan option you choose, your mortgage will bear long-term effects on your financial future. It may not be an easy decision, but doing the research upfront is certainly worth your time and effort.
If you’re ready to shop for homes, start your home buying journey today with help from a Rocket Homes℠ Verified Partner Agent.
Table of Contents
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