Are you thinking about purchasing a home? If so, it’s important to know about all of the different types of mortgage loans that are available to you. We’ll share the top 10 different types of mortgage loans, and discuss the pros and cons of each one so you can make the best decision for your family and your future. With so many choices, it can be difficult to know which one is the best fit for your needs. Does one provide better value than the others? What about loan terms, interest rates, and other points of comparison? In today’s post, we’re going to break down all the details you need to know.
1. Conventional Loans
A conventional loan is any type of home loan that the federal government does not back. These types of loans typically require a higher credit score than most (620 or above). They can also be harder to qualify for than other, government-supported mortgages.
Home buyers interested in conventional loans must also make a down payment as an initial, up-front investment. The standard is 20% of the home’s total purchase price. While a down payment of less than 20% can be acceptable, those buyers are usually required to pay private mortgage insurance (PMI).
Lenders require PMI to protect themselves in the event that the borrower defaults on the loan. Down payments of less than 20% are considered riskier, and PMI helps offset this risk. Once you reach 20% equity, the PMI payments will cease.
There isn’t a set cost of PMI, as it depends on a few different factors. These include:
- The size of the mortgage loan
- Your credit score
- The amount of your down payment
- The type of mortgage you’re applying for
Today, the most common type of conventional loan is called a conforming loan. This is a loan that adheres to all of the underwriting guidelines set forth by Fannie Mae and Freddie Mac.
Conforming loans have specific limits, and these typically change each year to accommodate changes in home values.
In 2022, the conforming loan limit is $647,200 for most single-family homes in the United States. In high-cost areas and certain states and territories (Alaska, Hawaii, Guam, and the U.S. Virgin Islands), the conforming loan limit is $970,800.
Key Features of a Conventional Loan
Interested in applying for a conventional mortgage loan? Here are the high-level details to know:
- Requires a minimum credit score of 620
- Most require a down payment of at least 20%
- Approval requires an in-depth look at your personal history (income, employment, credits, debts, assets)
Pros of Conventional Loans
The advantages of a conventional loan include:
- Even if you have to pay PMI, it will stop after you have 20% equity in the home
- You can use it for a variety of different purchases, including primary homes and vacation/investment properties
Cons of Conventional Loans
Here are the downsides of a conventional loan:
- You have to pay some type of down payment (at least 3%)
- You must pay PMI if you can’t afford a 20% down payment
Who Should Apply for a Conventional Loan?
Conventional loans can be secure, steady funding options for prospective home buyers. This is often the best loan for individuals who:
- Have a stronger credit score
- Have a steady income and solid employment history
- Can afford a higher down payment
2. Adjustable-Rate Mortgages
An adjustable-rate mortgage (ARM) has a variable interest rate. Instead of paying a fixed percentage of interest each month, your rate will change intermittently over the repayment term.
In an ARM, there is an initial period at the beginning where your interest rate does stay the same. Then, once that period is over, the rate will start adjusting on a reoccurring basis.
One of the most popular types of ARMs is a 5/1 ARM. With this type of loan, your interest rate will be locked in place for an initial period of five years. After that, it will adjust once each year for the rest of the loan term.
ARMs are usually attractive to buyers because their initial interest rates are usually low. However, they can rise up to five percentage points above fixed-rate loans once the adjustment period kicks in. This is known as the lifetime adjustment cap, and the rate cannot jump by more than this over the life of the loan.
Key Features of an ARM
Is an ARM for you? Here are the highlights:
- Begins with a lower interest rate than most fixed-rate loans
- Will always include a variable rate, which fluctuates with market conditions
- Include a lifetime adjustment cap, which means your variable rate can’t increase by more than five percentage points
Pros of ARMs
The benefits of an ARM include:
- You can save money in the initial period when interest rates are usually very affordable and competitive
- You can pay less in interest over the life of the loan, especially if your initial fixed rate is low
Cons of ARMs
The downsides of an ARM include:
- You assume a degree of risk because you don’t know what your rates will be once the initial period is over
- If you sell the house before your fixed-rate period is over, you could lose money if the market turns or the house loses value
Who Should Apply for an ARM?
An ARM can be ideal if you know that you won’t be in your new home for longer than the initial, fixed-rate term. For instance, if you are only relocating for four years and you have a 5/1 ARM, you can take advantage of the low rate at the beginning, and hope that the market remains steady when it’s time to sell.
3. Fixed-Rate Mortgages
Unlike an ARM, a fixed-rate mortgage (FRM) includes an interest rate that stays the same over the lifetime of the loan. Unless you decide to refinance your mortgage down the road, the rate that you see on your closing date is the same one you’ll pay for the entire term.
The two most common types are 15-year and 30-year fixed-rate mortgages.
Key Features of an FRM
Here are the main details to know about fixed-rate mortgages:
- The interest rate remains the same and will not change over the course of the loan
- While custom repayment terms are available, most are in five-year increments (20-year, 25-year, 30-year)
Pros of FRMs
The benefits of an FRM include:
- They are stable and predictable, which helps you manage your household budget
- You always know what your monthly principal and interest payments will be
Cons of FRMs
The disadvantages of an FRM include:
- Their interest rates are usually higher than the initial rate period of an ARM
- They usually come with longer repayment terms, so you’ll pay more interest over the long term
Who Should Apply for an FRM?
An FRM is best for borrowers who favor a stable and steady rate over the course of their loan. With an FRM, it’s easier to manage your monthly expenses and plan for big purchases, because your monthly payment will not change.
4. Jumbo Loans
As their name implies, jumbo loans are larger than conventional loans. Most borrowers use them to afford large-scale, luxury homes. These loans exceed all conforming loan limits and do not conform to the guidelines set forth by Fannie Mae and Freddie Mac.
Eligible homebuyers could qualify to borrow up to $1 million or more with a jumbo loan. This is larger than the limit on a high-balance loan. However, because these loans are considered riskier investments, they usually require a down payment of at least 20%.
Key Features of a Jumbo Loan
The main features of a jumbo loan include:
- They allow homebuyers to borrow large loan amounts, even if those amounts exceed current conforming loan limits
- They usually require a substantial down payment
- Lenders will enforce stricter credit scores and down payment requirements than they would with a conforming loan
Pros of a Jumbo Loan
Thinking about a jumbo loan? Benefits include:
- Interest rates are usually close to conforming, conventional loan rates
- You can use it to purchase a variety of property types (including vacation and luxury homes)
Cons of a Jumbo Loan
The disadvantages of a jumbo loan include:
- Lenders require high credit scores (at least 680) and are strict about requirements
- You will need to put down a large down payment, especially when buying a second home or investment property
Who Should Apply for a Jumbo Loan?
Jumbo loans are designed for borrowers who need a large mortgage loan but do not live in designated high-cost areas, where a high-balance loan would be ideal. These are meant for mortgages that exceed conforming loan limits.
5. High-Balance Loans
The Federal Housing Finance Agency (FHFA) sets special loan limits for localities that are deemed to be “high-cost areas”. In these regions, loan balances can exceed the standard conforming loan limits, though they are still considered to be conforming loans.
As mentioned, the high-balance loan limit for 2022 is $970,800. This is 150% of the standard limit for most single-family homes in the U.S.
Key Features of a High-Balance Loan
The main facts to know about high-balance loans include:
- They allow homebuyers to borrow above the standard loan limits in high-cost areas
- Although they have higher limits, they still follow Fannie Mae and Freddie Mac guidelines (unlike jumbo loans)
Pros of High-Balance Loans
The benefits of high-balance loans include:
- They make conforming loans more accessible for borrowers in high-cost areas
- They usually offer lower interest rates and more favorable terms than jumbo loans
Cons of High-Balance Loans
A high-balance loan isn’t ideal for all borrowers. Drawbacks include:
- They are only accessible in certain areas and regions throughout the U.S.
- While rates are lower than jumbo loans, they’re often higher than what you’d pay on a typical conventional loan
- Borrowers don’t have access to the 3% down-payment loan option available through Fannie Mae
- All co-borrowers have to have a credit score (Fannie Mae requirement)
Who Should Apply for a High-Balance Loan?
A high-balance loan can be a good option for someone who lives in a high-cost area but doesn’t want to pursue a jumbo loan. This type of loan will allow them to secure a conventional loan despite the local elevated cost of living.
6. FHA Loans
An FHA loan is backed by the U.S. Federal Housing Administration (FHA). These loans make mortgages more accessible for borrowers whose credit scores need work, as well as people who can’t apply the standard 20% down payment.
Down payment amounts usually decrease as credit scores increase. For instance, if your score is between 500 and 579, most lenders will require a 10% down payment. If your score is at least 580, it usually drops to only 3.5%.
In 2022, the FHA loan limit for most counties in the U.S. is $420,680 (for a single-family home). This is 65% of the national conforming loan limit. The FHA loan limit in high-cost areas remains $970,800 (like other high-balance loans).
One important consideration: These loans require borrowers to pay special FHA mortgage insurance.
If your down payment is less than 10% of the home’s total price, then you’ll pay that insurance premium for the full life of the loan. If your down payment is 10% or more, you’ll pay insurance for 11 years. The only way to change your insurance payment is to refinance your FHA loan into a conventional loan once you’ve built up 20% equity.
Key Features of an FHA Loan
Top-level details of an FHA loan include:
- Most borrowers will pay FHA mortgage insurance premiums
- The minimum down payment amount is 3.5% and borrowers only need a credit score of 580 to qualify
- You can use them to purchase multi-unit properties (up to four units) with just 3.5% down
Pros of FHA Loans
The advantages of an FHA loan include:
- Both first-time and repeat buyers can apply
- Qualification requirements are more lenient than conventional loans
- There are no income caps in place
Cons of FHA Loans
- Borrowers must live in the property they buy, even if you purchase a multi-unit property and rent out the other units
- Borrowers must pay FHA mortgage insurance for at least 11 years
- Loan limits are usually lower than what you could get with a conventional loan
Who Should Apply for an FHA Loan?
An FHA loan is best for borrowers who don’t have high credit scores or the ability to apply a high down payment to their mortgage. If your score is 580 or below, an FHA loan could help you buy a home without cutting too deeply into your savings.
7. USDA Loans
A USDA loan is backed by the U.S. Department of Agriculture (USDA). These loans appeal to homebuyers with low-to-moderate incomes, looking to purchase a home in a rural area.
USDA loans do not typically require a down payment, nor do they require borrowers to pay any type of mortgage insurance. However, your income must fall into specific brackets before you can qualify.
Key Features of a USDA Loan
Key features of USDA loans include:
- Borrowers can avoid a down payment and monthly insurance premiums
- To qualify, buyers must live in USDA-designated rural areas
Pros of USDA Loans
The pros of a USDA loan include:
- There is no insurance or down payment required
- You can use the loan to finance different types of homes, including:
- Single-family homes
- Modular homes
- Newly-built homes
- Manufactured homes
Cons of USDA Loans
The cons of a USDA loan include:
- The property must be a borrower’s primary residence
- Some loans prohibit certain property sizes and amenities
- There is an annual guarantee fee that all borrowers must pay
Who Should Apply for a USDA Loan?
A USDA loan is best for borrowers who live in USDA-designated rural areas and want a loan without a down payment. Most borrowers have modest incomes that prevent them from applying for other types of loans.
8. VA Loans
A VA loan is backed by the U.S. Department of Veterans Affairs (VA). Only military service members, veterans, and their eligible spouses qualify to apply.
Like USDA loans, most VA loans do not require a down payment, though some do. In addition, there isn’t a minimum credit score required to apply. However, many lenders will only approve borrowers who have a credit score of at least 620.
While some loan limits exist, these are not applied to borrowers who have:
- Paid off their existing VA loans completely
- Never used their VA loan benefits
Key Features of a VA Loan
The main facts about a VA loan are:
- Most do not require a down payment
- It makes it easier for service members, veterans, and eligible spouses to purchase a home
Pros of VA Loans
The best parts of a VA loan are:
- Borrowers don’t have to pay mortgage insurance
- There are no loan limits or down payments required
- Interest rates are usually competitive
- You can use the money to buy/build a home, as well as renovate/buy a manufactured home
Cons of VA Loans
The disadvantage of a VA loan include:
- Borrowers can only use appraisers and builders that the VA approves
- Borrowers must pay a VA funding fee
Who Should Apply for a VA Loan?
VA loans can be great options for qualified military borrowers. They’re especially ideal for borrowers who need access to a 0% down payment loan.
9. Reverse Mortgages
Homeowners who are at least 62 years old can apply for a reverse mortgage.
With this type of mortgage, your lender will make payments to you, rather than the other way around. These are different from other, traditional mortgages, which are considered “forward” loans.
To make the payments, your lender will access your available equity. They can provide the payment in one lump sum, or spread it out in monthly increments.
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM). The FHA insures HECM mortgages, and there are several initial and ongoing costs to consider. These include:
- Lender fees (up to $6,000)
- Annual insurance premiums (0.5% of the total loan amount)
- An initial mortgage insurance premium (2% of the home’s total value)
There are also loan limits in place for a reverse mortgage. In 2022, the HECM loan limit is For 2022, is $970,800. Ways to repay this loan include:
- Selling your home
- Refinancing your home and taking out a new, forward mortgage
Key Features of a Reverse Mortgage
The main features of a reverse mortgage include:
- You must have at least 50% equity in your home to qualify
- You don’t have to make payments until you sell your home or the borrower moves out/dies
- Borrowers (or surviving spouses) must maintain the home, use it as a primary residence and pay property taxes/homeowners insurance
Pros of Reverse Mortgages
The benefits of a reverse mortgage include:
- There are no debt-to-income ratio or income requirements
- You can use it to pay off your first mortgage
- You can use it to purchase a home
- You don’t have to make monthly payments unless you move out
- It prevents your heirs from inheriting an underwater mortgage (where the value is lower than the initial mortgage principal)
- The IRS does not tax income your receive from your reverse mortgage payouts
Cons of Reverse Mortgages
The disadvantages of a reverse mortgage include:
- If you’re married, lenders will go by the youngest spouse’s age
- The property could foreclose if you don’t maintain the house or pay property taxes/homeowners insurance
- Require substantial fees and associated costs
Who Should Apply for a Reverse Mortgage?
A reverse mortgage is designed for homeowners age 62 and older, who have at least 50% equity in their home. You can use the monthly payments as supplemental income throughout your retirement.
10. Home Equity Loans and HELOCs
Home Equity Loans and Home Equity Lines of Credit (HELOCs) are both considered second mortgages.
They are different from other types of mortgages because they allow you to borrow against the equity you’ve been accruing in your home over time. In other words, they’re secured by your current property. In the event of a foreclosure, your first mortgage will be repaid first, followed by your second mortgage.
A home equity loan is a lump-sum loan that includes a fixed interest rate. You’ll repay it over a set period of time through fixed installments.
An HELOC is distributed as a revolving credit line. In many ways, it’s similar to a credit card. The interest rate will vary, though you can use, repay, and reuse the funds as long as you have access to the credit line.
Key Features of a Home Equity Loan or HELOC
The main details to know about these loans include:
- Your home acts as collateral
- You can use the money for a variety of purposes, including home improvement projects and debt consolidation
- Both lump-sim and revolving credit options are available
Pros of Home Equity Loans or HELOCs
The advantages of these loans include:
- Some borrowers can access them even without a first mortgage in place
- You can use them to purchase, update, or refinance your home
Cons of Home Equity Loans or HELOCs
The disadvantages of these loans include:
- Interest rates can be higher than those on your first mortgage
- Qualification requirements are also stricter
Who Should Apply for a Home Equity Loan or HELOC?
If you have other financial goals you need to cover, a home equity loan or HELOC can be helpful. This might include funding a major repair or upgrade, consolidating your debt, and more.
Research the Different Types of Mortgage Loans
As you can see, there are many different types of mortgage loans available! To figure out which one is right for you, speak to your financial advisor or a trusted real estate agent. There are many factors to consider, including your budget, goals, and plans for the future.
As you browse available options, we’re here to help you find the Triangle home of your dreams. Take a look at our available properties today and contact us to connect!