Buying a home is one of the most important decisions that you and your family will make over their lifetimes. With so many to choose from, it can quickly become a daunting task as you try to make sense of the various qualifications and stipulations. Factors like interest rates, loan terms, and your overall housing budget will also have an impact on the type of loan that you choose.
However, a mortgage isn’t as simple as getting an approval letter, and signing your name to a piece of paper known as deed or title. There are in fact several different types of mortgage loans that you can essentially qualify for, and each one comes with it’s own benefits and disadvantages.
Conventional mortgages are those which fit into a non-traditional model as they are not typically financed by standard government institutions. Due to the structure of these loans, they may or may not abide by regulations set forth by the Federal Housing Finance Agency dependent upon the one that you choose
The following types of loans fall under this category:
Non-conforming – This type of loan is generally set aside for borrowers who are looking to close on an above average home. They also cater to those who may have blemishes on their credit history such as less than stellar scores or recent bankruptcy proceedings.
Conventional – These loans are bound by the FHFA, which is an independent agency providing oversight to several industry giants. Along with annual loan limits, budget requirements, and credit factors, the loans are also held to monitoring by the Federal Home Loan Bank System.
- Buyers and sellers can provide a portion of closing costs
- Freddie Mac or Fannie Mae loans allow for down payments of 3 percent
- Private mortgage insurance can be stopped once an equity of at least 20 percent is gained
- Lower borrowing costs compared to other mortgages
- Interest paid over course of the loan is less
- Requirements to qualify are a lot more strict
- Down payments costs outweigh other types of loans
- Stringent documentation verification required regarding income and employment
- Debt to income ratio cannot exceed more than 43 percent in most circumstances
- Qualifying credit score of at least low 600s is required
Fixed Rate Mortgages
Fixed rate mortgages are those loans guaranteed for a typical term, with a set rate for the life of the loan. These mortgages are typical with buyers who want to spread the principle and interest rate over the course of fifteen to thirty years or prefer a locked-in rate.
A fixed rate may appeal to homebuyers who prefer predictability without a huge fluctuation in monthly payments as taxes or property insurance rates increase over time. Although they contain many of the same terms and conditions, the differences between the two can be subtle.
30 Year Fixed – Thirty year mortgages are locked in with a stationary interest rate as well as principal payment throughout the entire duration. Considered as the original mortgage, these terms provide buyers who are seeking out a multi-generational asset that can be passed down or refinanced for equity.
15 Year Fixed – Fifteen year mortgages are similar to their predecessor, however they allow homeowners the option to pay off the balance within half of the normal time frame. Interest rates and principal payments remain the same during the loan term, which ends up costing less due to the amount of years with financing.
- Non fluctuating interest rates over the loan term
- Long term equity building strategy
- Additional monthly payments allowed for quicker paydown
- Ability to stick with a budget due to reliable payment structure
- Interest rates cannot be changed once locked-in
- General interest rates are typically more than adjustable rate mortgages
- Longer loan terms require substantially more interest paid out
- Refinancing can be more difficult if equity limits aren’t reached
Adjustable Rate Mortgages (ARM)
Adjustable rate mortgages allow the homebuyer to enter into much shorter loan contracts. They provide the option of choosing from three different mortgage terms to suit their budget needs. The ability to choose from a variety of loans allows flexibility for the buyer who is set on paying off the mortgage in the fastest amount of time.
While these mortgages come with many benefits to potential homebuyers as well as complete autonomy over the type of loan desired, there are some caveats to this kind of mortgage that should be heavily considered before purchasing a home.
- The ability to choose from terms of three, five, or seven year loans
- Several years of lower rates during pre-adjustment period
- Large savings on interest related payments
- Immediate interest rate variability after the agreed upon term is completed
- Possible instability of home values causing potential upside down mortgage
- Higher risk of loan default or foreclosure
Interest Only Mortgage
The interest-only mortgage was specifically created to appeal to a certain degree of homebuyer, such as those with high incomes, inherited savings, or variable cash flow during the year. The loans allow the buyer to pay down interest ahead of time by applying by refraining from principal payments over a specified time frame.
Although the interest is able to be reduced at a quicker pace, the amount owed on the principal or actual loan amount is not lowered whatsoever. Therefore, loan approval relies heavily on documentation highlighting the ability to pay.
- Convenient borrowing mechanism for short term loans
- Allows for flexible principal payments
- A preferred vehicle for those intent on refinancing or selling
- Significant assets required for minimum qualifications
- Equity building is slower due to initial payments being interest only
- Higher payments begin once predetermined time frame ends
Jumbo mortgages are types of loans that benefit potential buyers residing in HCOL parts of the country. Typically, they are found in parts of the country that contain big cities and are considered extremely risky for financial lending institutions.
These loans also don’t adhere to some regulatory limits of oversight agencies although they do require much stricter documentation, higher assets, and stellar credit scores to qualify. However, the loan amounts are significantly higher than traditional mortgage amounts, hence the name jumbo.
- Loan interests rates are in the neighborhood of traditional loans or lower
- Substantial amount of funds available for home purchases
- Preferred for those with excellent credit scores
- Debt to credit limits cannot exceed 45 percent
- Down payments required to be significantly higher of at least 20 percent
- Interest rates may be adjustable or fixed
A balloon mortgage is a type of loan that provides the borrower with the opportunity to have decreased monthly payments with a lump sum due at the end of the loan term. These loans are usually designed to meet the standards of a thirty year mortgage, however the homebuyer only keeps the loan for about seven years on average.
The balloon at the end of the term is due to the mortgage not being amortized like a traditional loan, or set up in such a way that would spread payments evenly over the entire life span. While loan eligibility may not be as difficult to obtain, the borrower’s ability to repay the loan may depend on several factors.
- Approval higher when traditional financing isn’t available
- Buyer seen as less of a credit risk due to length of the loan term
- Ability to request interest only payments in some circumstances
- Loans set for refinancing can result in additional loan fees
- Extremely high lump sum payment due at the end of the loan term
- Home equity accumulated in much longer time frame
Government Insured Mortgages
Government insured mortgages are loans that are backed by governmental institutions. They are considered less riskier than traditional mortgage lenders due to the ability to assume the losses if the borrower defaults for most reasons.
Traditionally these mortgages have been more appealing to those with credit situations, rural homebuyers, and military veterans who served in the Armed Forces. Requirements for these loans are much less stringent as they include a wider range of homebuyers.
There are three loan programs that fall under this category:
FHA Loans – A Federal Housing Administration (FHA) loan is a mortgage made to buyers who have credit blemishes and may not have high amounts of funding available for down payments. Some lenders allow qualifications as low as a 500 credit score when applying as well as down payments of less than 4%.
VA Loans – VA loans are mortgages secured by the Department of Veterans Affairs (VA), an agency that serves members of the Armed Forces including their families, reservists, as well as active duty military. Members qualify based on factors such as length of service, credit tiers, and other guidelines set forth by the Veterans Administration.
USDA Loans – USDA loans are mortgages which are made available to rural homebuyers, and guaranteed by the United States Department of Agriculture (USDA), who may not qualify for traditional financing. These loans are appealing due to a variety of factors including the lack of down payment required, grant availability, as well as lower loan eligibility guidelines.
- Interest rates are typically much lower due to less borrower risk
- Criteria for qualification is not as strict for approval
- A viable alternative for those with low savings
- Some loans have various types of subprograms to categorize qualification
- Insurance premiums typically required on most loans
- Owner occupancy is required for a length of time which may not appeal to investors
Mortgage loans allow homebuyers and investors the ability to acquire an asset for selling purposes, or a family home of your dreams. Choosing the right loan for you depends on weighing the factors for loan qualification such as credit scoring, down payment requirements, asset evaluation and other criteria. The mortgage loans listed above can give you a glimpse into the mortgage process in order to assess your own situation and meet your own family’s needs.