The Different Types of Mortgages
So, you’ve started to do your research and the details about the different types or mortgages are a little more confusing than you thought. Well, look no further! Home.loans is going to break it down for you.
What are the different types of mortgages?
The first thing you should know is that there are two common kinds of mortgages:
Fixed-rate mortgage (FRM)
Adjustable-rate mortgage (ARM)
The fixed-rate mortgage (FRM) is one of the most standard and frequently used interest rates for home loans. It does not change based on the market; it stays the same for the entire length of the mortgage term, which is often 15 or 30 years. The fixed-rate mortgage relies on a steady concept that the homebuyer will make the same monthly payment for the duration of the loan agreement.
The fixed-rate mortgage is ideal because regardless of the market, you don’t have to pay more in interest. There are also no limitations on prepayment. So if you want to make extra payments towards the principal, you’ll only benefit. (And pay off your house sooner!) However, these favorable terms make it hard for some to get approved.
The adjustable-rate mortgage (ARM) has interest rates that as the title implies—adjust. ARM rates typically change after 5 or 7 years. (In rare occasions, ARMs will adjust every 10 years.) So for a 5/1 ARM, the first five years of the loan will feature a fixed interest rate, but it’ll be evaluated yearly until the loan is paid in full.
Adjustable rate mortgages have lower rates than fixed-rate mortgages, which means an increase in buying power. However, there is uncertainty about this type of loan because you never know when the interest rate could change after that fixed period.
Another way to categorize your home loan options is by size. Conforming loans are under a specific size that's predetermined by Fannie Mae and Freddie Mac. As of 2017, this was $424,100 for a single-family home. Jumbo loans, on the other hand, are loans over the conforming amount.
But wait -- there are still other types of home loan options!
Here's a bit more detail on each of these types of mortgages.
FHA Loans
If you don’t have the 20% down or have had some other reason why a fixed-rate mortgage out of your reach, there is the FHA loan. An FHA loan is a Federal Housing Administration (FHA) loan. These loans are easier to qualify for due to its flexibility. It has low down payments at 3.5 percent of the house price and a minimum credit score of 580.
Under the FHA loan, it mandates that homebuyers pay mortgage insurance at around 0.85 percent of the total loan amount every year. The private mortgage insurance that FHA loans require is referred to as PMI.
FHA loans are ideal for first-time home-buyers, borrowers with low incomes, and those with moderate to poor credit. FHA loans make up nearly 40% of all loan types in the country right now due to its flexibility toward getting approved and its small down payment. It has more lenient restrictions on debt to income ratios, which can help buyers with moderate to poor credit. However, with a credit score lower than 580, your monthly mortgage payments may be higher due to interest. Improving your credit score can lessen some of these problems.
USDA Loans
A USDA home loan is offered to individuals who make no more than 115% of their area’s median income. Typically, borrowers of a USDA loan have difficulties getting approved for a fixed-rate or adjustable-rate mortgage. As a 100% financed mortgage for low-income borrowers, putting no money down is a benefit.
Other characteristics are that it has the lowest PMI rate. While there is an upfront mortgage insurance payment, borrowers pay little for the PMI because of the reduced rate which is typically at 0.30%. Loans are granted through the U.S. Department of Agriculture and are similar to FHA loans. However, a lot of the eligibility for this loan relies on location. Only 3% of the country lives in a qualified zone.
Additional Requirements for the USDA Home Loan:
Borrowers must use the property as their primary residence
Prospective homebuyers must have a credit score of at least 620
They must live in an eligible location
Must wait at least 36 months or more after bankruptcy to apply for a USDA home loan
VA Loans
The VA loan is a mortgage type guaranteed by the U.S. Department of Veteran Affairs (VA). It is offered to military service veterans and active military members. Like the USDA loan, no money down is an option. The government insures the lenders against possible borrower non-repayment.
There are a few requirements for VA home loan approval. You must meet one of the criteria below:
You or your spouse must have served at least 6 years in the National Guard
You or your spouse must have served at least 90 consecutive days during a wartime
You or your spouse must have served at least 181 days during a peacetime in the military
You served your country and now this loan system wants to make sure they serve you! The VA works to help service members stay on top of their mortgage and avoid lapsed payments or foreclosure. They work with you to create a realistic and favorable repayment plan so that you may truly own your home through this type of loan.
Because this benefit mortgage is guaranteed by the Department of Veterans Affairs, there is no minimum credit score requirement and no borrowing amount limit. The VA loan is one of the few home loan options for borrowers who may not have enough for a down payment. However, because it is available to countless active and veteran members of the United States military, VA loans are easier to get approved for.
The VA loan works to benefit military service members. A VA lender will offer assistance to struggling borrowers if they cannot make payments or feel they might slip into foreclosure. The VA has helped borrowers with restructuring repayment plans, home loan modifications, and more.
For our brave military servicemen and women, we wish the VA home loan had existed much earlier!
Other Types of Home Loans
There are other loan products designed for current homeowners who aren't trying to buy a new home -- but rather, tap into the equity they've already built with their current home. These are called home equity loans and reverse mortgages. Homeowners can use a home equity loan (and a home equity line of credit) to access cash that's secured by the value of their home. A reverse mortgage is for homeowners over 62 years old who own their homes outright.