Navigating the home mortgage maze can be challenging, particularly for first-time buyers. Adding to the confusion is that several types of mortgage loans can fit into multiple categories used to define home finance.
To sort through the types of home mortgages available to you and ensure you understand the terminology, here is a quick primer on types of home mortgage loans:
Fixed or adjustable-rate mortgages
Every mortgage can be defined by the type of interest rate, whether fixed, adjustable, or a combination. Choosing whether to pursue a fixed-rate or an adjustable-rate loan will be one of the first decisions you will likely encounter as you apply for financing.
- As its name would imply, a fixed-rate mortgage is a home loan in which the interest rate remains constant throughout the life of the loan.
Many borrowers prefer a fixed-rate mortgage because they wish to avoid any surprises.
Even with long-term loans of 30 years, the monthly home payment remains the same, year after year, unless you decide to refinance your loan for a more favorable rate down the road.
By contrast, the interest rate for an adjustable mortgage, or ARM, will change yearly. In many cases, loans will have a limit on how much it can adjust up or down over the loan’s lifetime.
Often, a loan’s interest rate will not change until after a period following the loan’s initial velocity. For this reason, such ARMs are often referred to as hybrid products.
For example, a mortgage may carry the same interest rate for the first five years of the loan, then adjust on an annual basis.
The main advantage of a fixed-rate mortgage is the consistency of payments. However, your interest rate will be higher than an adjustable mortgage’s initial interest rate.
On the other hand, the interest rate of your ARM could later move upward to a point higher than the rate of a fixed-rate mortgage.
Government Insured or Conventional Mortgages
You’ll also have to decide whether to use a government-insured home loan or a conventional type of loan.
- A conventional home loan is a mortgage that the federal government does not guarantee. It typically requires a larger down payment and stricter criteria for qualifying.
By contrast, the three types of government-backed mortgages are insured by a federal government agency. While qualifying for a government-backed loan may be more accessible, more significant insurance costs may be added to your monthly payment.
Government-insured loans include:
- FHA. The Department of Housing and Urban Development sponsors the Federal Housing Administration (FHA) mortgage insurance program. While you must pay mortgage insurance, an FHA loan carries the advantage of requiring a smaller down payment, as low as 3.5 percent.
- VA. The Department of Veteran Affairs backs this government-insured loan available to military members and their families. Although similar to an FHA loan, this loan program makes home loans with as little as 0 percent down.
- USDA. The USDA loan home program is administered by the Rural Housing Service (RHS) administers the USDA loan home program. This type of mortgage loan is restricted to rural properties and borrowers who can show a modest income and do not qualify for conventional financing. Additional restrictions apply.
Conforming or Non-conforming
Conforming versus non-conforming loans is another set of terms you are likely to hear in conjunction with home financing. This differentiation refers to whether a loan meets Fannie Mae’s or Freddie Mac’s underwriting guidelines, the government-controlled corporations that purchase and sell mortgage-backed securities.
- A conforming loan falls within maximum size limits, as well as other criteria.
If a loan is non-conforming due to size, it is a jumbo loan. Because these loans represent a greater risk to lenders, they typically have higher interest rates and require more outstanding down payments and higher credit scores.
Understanding these different categories of home mortgages can help you understand your available home loan options. Remembering the combinations of mortgage types, such as fixed-rate FHA loans or adjustable-rate conventional mortgages, will help you better analyze your opportunities when financing your next home.