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Mortgage types can be a confusing subject for borrowers because there are so many kinds of home loans from which to choose. Home loans can be characterized by the way they’re underwritten and guaranteed. They can also be characterized by their rate structures — fixed versus adjustable.
One way to figure out types of mortgages is to divide them into two groups: government loans and non-government loans, which are called “conventional” mortgages. In this context, “government” means the loan is insured, backed or guaranteed by a federal government agency, using mortgage insurance or a funding or guarantee fee that’s paid by the borrower to protect the lender’s interest. FHA vs Conventional? VA vs USDA? It’s a difficult choice–one that this article is meant to help you make.
There are three main types of government mortgage loans:
The USDA loan is sometimes called a Rural Housing or RD loan, which refers to the Rural Development division within the USDA. There is no difference between a USDA loan and RD loan. The two are the same, despite their different names.
FHA, VA and USDA loans allow very small down payments, and in some cases they require no down payment at all.
The FHA minimum down payment is 3.5 percent. FHA loans require an upfront mortgage insurance premium of 1.75 percent plus a monthly mortgage insurance premium or MIP (that’s 1.35 percent per year for most loans). For applicants with credit scores under 580, the minimum down payment is ten percent. FHA monthly insurance applies during the entire life of the loan, which makes it one of the more expensive mortgage options.
The VA and USDA minimum down payment is zero, with a funding or guarantee fee that maybe be paid upfront or financed with the loan amount. USDA loans also require monthly mortgage insurance for the life of the loan, but the premiums are much lower than those of FHA home loans — .5 percent per year.
These loans also offer flexible underwriting guidelines, making it easier for less-qualified borrowers to obtain financing.
Most government and conventional home loans offer a choice of rate structures — fixed or adjustable.
Adjustable-rate mortgages are commonly known as ARMs.
Fixed-rate mortgages are what their name implies: mortgages with rates that do not change. ARMs come with lower introductory interest rates, which remain in effect for time periods ranging from one month to ten years. Once the introductory period expires, the loan’s rate begins resetting at regular intervals (usually every year or every six months). ARMs with introductory rates that are fixed for more than one year are often called “hybrid ARMs.” Typically, hybrid ARM introductory rates are fixed for three, five, seven or ten years.
Fixed mortgages come with higher rates that the introductory rates of ARMs. If rates stay low, or if the borrower sells or refinances before the introductory period ends, an ARM can be a money-saver. If rates fall, ARM borrowers get the benefit of a lower rate without doing anything, while those with fixed rates have to refinance or stay stuck with a higher rate. If rates rise, though, an ARM exposes the borrower to the risk of a higher rate and payment. ARM adjustments typically are subject to caps that protect borrowers from severe payment shocks.
Borrowers should research different types of home loans and discuss the benefits of each type with a reputable lender before they decide which best meets their needs
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