Many people mistakenly believe they can’t afford to buy a home because they don’t really know what their options are. Fortunately, home loans are not one-size-fits-all. There are a variety of different mortgages available to suit your budget and preferences.
So before you start visiting open houses, take some time to familiarize yourself with the different home loans that are available. Going into the home buying process informed could help you save a lot of money on your down payment, interest, and fees.
The 8 Types of Mortgage Loans Available
Understanding the different types of mortgage loans will help you choose the option that’s best suited for you. Let’s look at a brief overview of the eight types of mortgages available in 2021.
1. Conventional Loans
A conventional loan is a mortgage that’s not issued by the federal government. There are two different types of conventional loans you can choose from: conforming and non-conforming loans.
A conforming loan falls within the guidelines laid out by Frannie Mae and Freddie Mac. You’ll take out a conforming loan through a private lender like a bank, credit union, or mortgage company. Since the government doesn’t guarantee the loan, conventional loans typically come with more stringent lending requirements.
According to the CFPB, the maximum loan amount for a conventional loan is $484,350. However, it may be as high as $726,525 in counties with a high cost of living. You’ll have to take out primary mortgage insurance (PMI) if you don’t have a 20% down payment.
Conventional loans are fixed-rate mortgages which means your monthly payment remains the same throughout the entire life of the loan. The terms typically range from 10 to 30 years:
- 30-year fixed-rate mortgage
- 20-year fixed-rate mortgage
- 15-year fixed-rate mortgage
- 10-year fixed rate mortgage
Pros:
- Can be used to purchase a primary home or an investment property
- Tends to cost less than other types of loans
- You can cancel your PMI once you reach 20% equity in your home
Cons:
- Must have a minimum FICO score of 620 or higher
- Harder to qualify for than government-backed loans
- You’ll need to have a low debt-to-income ratio to qualify
2. Conventional 97 Mortgage
A conventional 97 mortgage is similar to a conventional loan in that it’s widely available to a variety of borrowers. The main difference is that with this type of home loan, you only have to pay a 3% down payment.
The program is available for first-time and repeat home buyers. However, it must be your primary place of residence, and the maximum loan amount is $510,400.
Pros:
- Widely available to most borrowers
- Only requires a 3% down payment
- Available for first-time and repeat homebuyers
Cons:
- Cannot be used to purchase investment properties
- The maximum loan amount is $510,400
- Requires a minimum FICO score of 660 or higher
3. FHA Loans
FHA loans are backed by the Federal Housing Administration and are a popular option for first-time home buyers. To qualify, you need to have a 3.5% down payment and a minimum credit score of 580.
If you have a credit score of 500 or higher, you can qualify for an FHA loan with a 10% down payment. These flexible requirements make FHA loans a good option for borrowers with bad credit.
To qualify for an FHA home loan, you must have a debt-to-income ratio of 43% or less. These loans can’t be used to purchase investment properties, and your home must meet the FHA’s lending limits.
These limits vary by state, so you’ll need to check the FHA’s website to see what the guidelines are for your area.
Pros:
- Loans come with low down payment options
- A good option for borrowers with bad credit
- Available for first-time and repeat homeowners
Cons:
- Loans can’t be taken out for investment properties
- If your credit score is below 580 a 10% down payment is required
- You must have a debt-to-income ratio below 43%
4. FHA 203(k) Rehab Loans
An FHA 203(k) rehab loan is sometimes referred to as a renovation loan. It allows home buyers to finance the purchase of their home and any necessary renovations with a single loan.
Many people purchase older homes to fix them up. Instead of taking out a mortgage and then applying for a home renovation loan, you can accomplish both within a single mortgage.
A rehab loan is similar to an FHA loan in that you’ll need a 3.5% down payment. However, the credit requirements are stricter, and you’ll need a minimum credit score of 640 to qualify.
Pros:
- Allows you to buy a home and finance the remodel within one mortgage
- Requires a minimum 3.5% down payment
- Easier to qualify since the FHA backs your loan
Cons:
- Credit requirements are more stringent than typical FHA loans
- You must hire approved contractors and cannot DIY the renovations
- The closing process takes longer than other types of mortgages
5. VA Loans
The Department of Veteran Affairs guarantees VA loans. These loans are designed to make it easier for veterans and service members to qualify for affordable mortgages.
One of the biggest advantages of taking out a VA loan is that it doesn’t require a down payment and no private mortgage insurance. And there are no listed credit requirements, though the lender can set their own minimum credit requirements. VA loans typically come with a lower interest rate than FHA and conventional loans.
To qualify for a VA loan, you must either be active duty military, a veteran or honorably discharged. You’ll need to apply for your mortgage through an approved VA lender.
Pros:
- No down payment required
- No PMI required
- Flexible credit requirements
Cons:
- Must be a veteran to qualify
- Some sellers will not want to deal with a VA loan
6. USDA Loans
A USDA loan is a type of mortgage that’s available for rural and suburban home buyers. It’s a good option for borrowers that are having a hard time qualifying for a traditional mortgage.
USDA loans are backed by the U.S. Department of Agriculture, and they help low-income borrowers find housing in rural areas. USDA loans to not require a down payment, but you will need a minimum credit score of 640 to qualify.
You will need to meet the USDA’s eligibility requirements to qualify for the loan. But according to the department’s property eligibility map, over 95% of the U.S. is eligible.
Pros:
- No down payment required
- A good option for low-income borrowers
- Available to first-time and repeat home buyers
Cons:
- A minimum credit score of 640 is required
- Housing is limited to rural and suburban areas
7. Jumbo Loans
A jumbo loan is a mortgage that exceeds the financing guidelines laid out by the Federal Housing Finance Agency. These loans are unable to be purchased or guaranteed by Fannie Mae or Freddie Mac.
A jumbo loan is financing for luxury homes in competitive real estate markets, and the limits vary by state. In 2021, the FHFA raised the limits for a one-unit property to $548,250, increasing from $510,400 in 2020.
If you’re hoping to buy a home that costs more than $1 million, you’ll need to take out a super jumbo loan. These loans provide up to $3 million to purchase your home. Both jumbo and super jumbo loans can be difficult to qualify for and require excellent credit.
Pros:
- These loans make it possible to purchase large homes in expensive areas
- Typically comes with flexible loan terms
Cons:
- Jumbo loans and super jumbo loans come with higher interest rates
- You’ll need a good credit history to qualify
8. Adjustable Rate Mortgages (ARMs)
Unlike a fixed-rate mortgage, where the interest rate is set for the life of the loan, an adjustable-rate mortgage (ARM) comes with interest rates that fluctuate. Your interest rate depends on the current market conditions.
When you first take out an ARM, you will typically start with a fixed rate for a set period of time. Once that introductory period is up, your interest rate will adjust on a monthly or annual basis.
An ARM can be a good option for some borrowers because your interest rate will likely be low for the first couple of years you own the home. But you need to be comfortable with a certain level of risk.
And if you choose to go this route, you should look for an ARM that caps the amount of interest you pay. That way, you won’t find yourself unable to afford your monthly payments when the interest rates reset.
4 Types of ARMs
There are 4 different types of adjustable-rate mortgages typically offered:
- One Year ARM – The one-year adjustable-rate mortgage interest rate changes every year on the anniversary of the loan.
- 10/1 ARM – The 10/1 ARM has an initial fixed interest rate for the first ten years of the mortgage. After 10 years is up, the rate then adjusts each year for the remainder of the mortgage.
- 5/5 and 5/1 ARMs – ARMs that have an initial fixed rate for the first five years of the mortgage. After 5 years is up, for the 5/5 ARM, the interest rate changes every 5 years. For the 5/1 ARM, the interest changes every year.
- 3/3 and 3/1 ARMs – Similar to the 5/5 and 5/1 ARMs, except the initial fixed-rate changes after 3 years. For the 3/3 ARM, the interest rate changes every 3 years and for the 3/1 ARM, it changes every year.
Pros:
- Interest rates will likely be low in the beginning
- If you pay the loan off quickly, you could pay a lot less money in interest
Cons:
- Your monthly mortgage payments will fluctuate
- Many borrowers have gotten into financial trouble after taking out an ARM
Bottom Line
As you can see, there are many different home loans for you to choose from. The type of mortgage that’s best for you will depend on your current income and financial situation.
If you’re not sure where to start, consider working with a qualified loan officer. They can assess your situation and recommend the option that will be best for you.
