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What are the Different Types of Mortgages?
Have you ever wondered what the different types of home loans are? Whether you’re thinking of buying a home for the first time or you’re moving onto a second home and/or investment property, a mortgage can help you finance your home.
Mortgages can be a great way to start building equity and assets without having to save up the cash to pay for the home outright. But while mortgages can take you from renter to homeowner, getting a mortgage is not exactly a straightforward process. Plus, there are many different types of mortgage loans available to home buyers, so it’s important to know what’s out there and how the process works before making such a significant financial commitment.
Most people have probably heard of a mortgage before, but what exactly is a mortgage? A mortgage is when a lender — which could be a bank, a credit union, another financial institution or a private lender — lends the borrower (you) the money to purchase a home. The lender theoretically buys the home for you in the form of a mortgage, which you then pay off with interest over a set number of years.
Mortgage loans have interest rates that come with them, which is how the lender makes money on the loan. The interest rate as well as the type of mortgage you get will depend on several factors, including your credit score, the amount you have saved up for your down payment, your debt-to-income ratio, your income, etc.
Your lender will review your personal and financial information and speak to you to determine which type of mortgage is best for you. As with any loan, you’ll want to check what the other fees exist (for instance, a loan origination fee or private mortgage insurance) before making a decision.
The first type of mortgage loan is a fixed-rate mortgage. This is a mortgage that has a fixed mortgage rate, which means the rate you pay for borrowing the money won’t change at all over the life of the mortgage. You lock your rate in at the time you get approved for your mortgage and close on the home, and that’s the rate that you’ll pay until you’ve finished paying it off.
If you can lock in a low rate when you first purchase your home, then a fixed-rate mortgage can be a great fit. You may be asked to put a down payment of anywhere between 3.5% and 20% depending on your lender.
Fixed-rate mortgages fall into a couple of categories:
15- or 20- year fixed-rate mortgage:
This is a mortgage that has a fixed-rate for 15 or 20 years. With these types of loans, you’re paying down your loan principal more quickly than normal, so your monthly payments will be higher than they would with a 30-year fixed-rate mortgage. However, you will pay off your loan in about half the time it traditionally takes people to pay off their mortgages. These loan terms are recommended for people who are able to afford the higher monthly payments.
30-year fixed-rate mortgage:
A 30-year fixed-rate mortgage can, in many cases, be thought of as a “traditional” mortgage, as most people take 30 years to pay off their home. The benefit of this type of mortgage is that you’ll have lower monthly payments when compared to the shorter-term loans. The downside is you’ll be paying it for the next 30 years, which means you’ll pay more in interest over the long haul.
It’s also important to remember that a lot can happen in 30 years, so if you plan on purchasing a home with this loan term, be sure you’ll be able to afford the payments, even if an extenuating circumstance — a job loss, the birth of a child, or someone gets sick, for example — cuts into your savings.
Another type of mortgage loan is an adjustable-rate mortgage, also known as a “variable-rate” mortgage. This type of mortgage loan is essentially the opposite of a fixed-rate mortgage, which means that the interest rate can be adjusted at certain points, and will go up or down depending on the indexes related to the loan.
ARM loans generally start out with a fixed interest period followed by a variable period in which your rate can fluctuate each year. The upside to an adjustable-rate mortgage is that it generally has lower rates during the fixed portion than a fixed-rate mortgage would, which is why some people opt for them. For others, this type of loan may be risky because your monthly payments can increase when you’re not expecting them to.
It’s a roll of the dice, really. An adjustable-rate mortgage could mean getting potentially lower payments as well if rates drop during your variable term. If they rise, though, it could put your monthly payments well outside of what you can afford.
A VA loan, or a Veteran’s Association loan, is a loan for veterans, active military members, and some family members of veterans or active military who qualify. One of the perks of this loan is that it has a 0% down payment requirement, which means it’s easier to get into a home without a significant amount of savings. Another perk is that the rates for VA loans are usually pretty low — and you won’t be required to pay for extra mortgage insurance premiums, even without the 20% down payment.
The downside is that to take advantage of a VA Loan, you’ll have to meet certain eligibility requirements based on parameters like when you completed your service, whether you’re a surviving spouse of a veteran, etc. These loans are extremely limited and are only offered to service members who qualify, so you can’t get one if you haven’t served in the armed forces.
The different types of VA loans include:
- VA-backed purchase loan
- Native American Direct Loan (NADL) Program
- Interest Rate Reduction Finance Loan (IRRRL)
- Cash-out refinance loan
[ Related: When Veterans Should Use a VA Loan ]
An FHA loan is a loan that’s backed by the Federal Housing Association. Though there are several types of FHA loans, they are all under HUD (the Department of Housing and Urban Development) and are ideal for people buying their first home or those with lower credit scores.
You can use a traditional FHA loan to purchase a variety of homes: from single-family homes to four-unit multi-family homes. Best of all, you only have to put down 3.5% as a down payment — but it will depend on your lender. Remember, though, that it’s always important to consider putting down a higher down payment depending on the situation.
FHA loans have looser requirements, too, so people with credit issues or low incomes may be able to buy a home with an FHA loan. These types of loans are issued by the same lenders that issue conventional loans — the FHA only backs the loan. It doesn’t issue them. So you have your choice of lender for this type of loan.
[ More: Guide to FHA Refinance ]
The downside to FHA loans is that you’re required to pay for extra mortgage insurance for much of the loan term. This protects the FHA from losses in case you default, and it can be pretty pricey depending on the amount of your loan.
Other types of FHA loans are:
- FHA 203K — This is a loan that can be used to purchase a home in need of repairs and get the funds to renovate.
- FHA energy-efficient mortgage
- FHA reverse mortgage
- FHA for mobile homes and manufactured homes
A jumbo mortgage is a mortgage loan that exceeds the amount allowed for conventional or federally-backed loans. These types of loans can be used to purchase a home with a price that exceeds the FHFA’s limitations on conforming loans. These limits vary depending on the area you’re buying in, but if the home you’re looking to purchase falls outside of the FHFA limitations, you will need to seek out a jumbo mortgage.
Unlike other mortgages — including conventional loans — a jumbo mortgage is not purchased, guaranteed or securitized by Fannie Mae or Freddie Mac. You will therefore need to provide your lender a much more comprehensive credit and financial picture in order to prove you can get this type of loan.
A USDA mortgage is a loan that’s backed by the United States Department of Agriculture. The loans are offered to low-income earners who are willing to buy a home in a USDA designated zone, which is typically in a rural area.
This is the main factor for eligibility, but there are different types of USDA mortgages which may have slightly different requirements. Like VA loans, USDA mortgages do not require a down payment — but you have to meet the requirements to be eligible.
The different types of USDA loans are:
- Single Family Housing Guaranteed
- Single Family Housing Direct
- Multi-Family Housing
- Rural Business
- Water and Environmental Guaranteed
- Community Facilities Guaranteed