What are the different types of mortgage loans?

Just as homes come in different styles and price ranges, so do the ways you can finance them. While it may be easy to tell if you prefer a rambler to a split-level or a craftsman to a colonial, figuring out what kind of mortgage works best for you requires a little more research. There are many different loan types to choose from, and a great lender can walk you through all of your options, but you can start by understanding these three main categories.

Fixed Rate Loan or Adjustable Rate Loan | Conventional Loan or Government Backed Loan | Jumbo Loan or Conforming Loan

Fixed Rate Loan or Adjustable Rate Loan

When deciding on a loan type, one of the main factors to consider is the type of interest rate you are comfortable with: fixed or adjustable. Here’s a look at each of these loan types, with pros and cons to consider.

Fixed-rate mortgages

This is the traditional workhorse mortgage. It gets paid off over a set amount of time (10, 15, 20 or 30 years) at a specific interest rate. A 30-year fixed is the most common. Market rates may rise and fall, but your interest rate won’t budge.

Why would you want a fixed-rate loan? One word: security. You won’t have to worry about a rising interest rate. Your monthly payments may fluctuate a bit with property tax and insurance rates, but they’ll be fairly stable. If rates drop significantly, you can always refinance. The shorter the loan term, the lower the interest rate.

For example, a 15-year fixed will have a lower interest rate than a 30-year fixed.
Why wouldn’t you want a fixed rate? If you plan on moving in five or even 10 years, you may be better off with a lower adjustable rate. It’s the conservative choice for the long term, which means you will pay for the security it promises.

Adjustable-rate mortgages (ARMs)

You’ll get a lower initial interest rate compared to a fixed-rate mortgage but it won’t necessarily stay there. The interest rate fluctuates with an indexed rate plus a set margin. But don’t worry — you won’t be faced with huge monthly fluctuations. Adjustment intervals are predetermined and there are minimum and maximum rate caps to limit the size of the adjustment.

Why would you want an ARM? Lower rates are an immediate appeal. If you aren’t planning on staying in your home for long, or if you plan to refinance in the near term, an ARM is something you should consider. You can qualify for a higher loan amount with an ARM (due to the lower initial interest rate). Annual ARMs have historically outperformed fixed rate loans.

Why wouldn’t you want an ARM? You have to assume worst-case scenario here. Rates may increase after the adjustment period. If you don’t think you’ll save enough upfront to offset the future rate increase, or if you don’t want to risk having to refinance, think twice.

What should I look for? Look carefully at the frequency of adjustments. You’ll get a lower starting rate with more frequent adjustments but also more uncertainty. Check the payments at the upper limit of your cap and make sure you can afford them. Relying on a refinance to bail you out is a big risk.

Here are the typical types of ARMs offered:

Balloon Mortgages

If you plan to sell or refinance your home within a few years and want a fixed, low monthly payment, then a balloon loan may work for you. Balloon loans offer lower interest rates for shorter term financing, usually five, seven, or ten years. At the end of the loan term there will be a remaining principal loan balance and the lender will require refinancing or paying off the outstanding balance with a lump-sum or "balloon" payment. Since this loan is a very short term loan and the lender is taking less risk, it is easier to qualify for this type than for a loan amortized over 30 years.

Conventional Loan or Government Backed Loan

You’ll also want to consider whether you want — or qualify for — a government-backed loan. Any loan that’s not backed by the government is called a conventional loan. Here’s a look at the loan types backed by the government.

Federal Housing Administration (FHA) loans

FHA loans are mortgages insured by the Federal Housing Administration. These loans are designed for borrowers who can’t come up with a large down payment or have less-than-perfect credit, which makes it a popular choice for first-time home buyers. FHA loans allow for down payments as low as 3.5 percent and credit scores of 580 or higher.

Because of the fees associated with FHA loans, you may be better off with a conventional loan, if you can qualify for it. The FHA requires an upfront mortgage insurance premium (MIP) as well as an annual mortgage insurance premium paid monthly. If you put less than 10 percent down, the MIP must be paid until the loan is paid in full or until you refinance into a non-FHA loan. Conventional loans, on the other hand, do not have the upfront fee, and the private mortgage insurance (PMI) required for loans with less than 20 percent down automatically falls off the loan when your loan-to-value reaches 78 percent.

Veterans Administration (VA) loans

This is a zero-down loan offered to qualifying veterans, active military and military families. The VA guarantees the loan for the lender, and the loan comes with benefits not seen with any other loan type. In most cases, you pay nothing down and you will never have to pay mortgage insurance. If you qualify for a VA loan, this is almost always the best choice.

USDA loans

USDA loans are backed by the United States Department of Agriculture (USDA) and are designed to help low- or moderate-income people buy a home small to medium sized communities in rural areas. Some suburban areas qualify, too. If you are eligible for a USDA loan, you can purchase a home with little or no down payment and get below-market mortgage rates.

Jumbo Loan or Conforming Loan

The last thing to consider is whether you want a jumbo loan or conforming loan. Let’s take a look at the difference between the two.

Conforming Loans

A conforming loan is any home loan that follows Fannie Mae and Freddie Mac’s conforming guidelines. These guidelines include credit, income, assets requirements and loan amount. Currently the limit in most parts of the country is $417,000, but in certain designated high-price markets it can be as high as $938,250.

Jumbo Loans

Loans that exceed this amount are called jumbo loans. They’re also referred to as non-conforming mortgages. Why would you want a jumbo loan? The easiest answer is because it allows you to buy a higher-priced home, if you can afford it. But these loans have flexibility that conforming loans don’t have, such as not always requiring mortgage insurance when the down payment is less than 20 percent. Why wouldn’t you want a jumbo loan? Compared to conforming loans, interest rates will be higher. And they often require higher down payments and excellent credit, which can make them more difficult to qualify for.

Summary

Choosing the best loan type for one’s situation will have a lot to do with and may be limited by the buyer’s credit score (credit history). The loan type will influence how large a loan can be considered, amount of down payment required, loan interest rate, escrow requirements and how quickly the loan can be processed and closed.

“What Type of Mortgage is Best for You” Retrieved from https://www.zillow.com/home-buying-guide/types-of-mortgages/ 

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