Find the home loan which best meets your needs
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.
Government Home Loans
There are three main types of government mortgage loans:
- FHA loan, insured by the Federal Housing Administration
- VA loan, guaranteed by the U.S. Department of Veterans Affairs
- USDA loan, backed by the U.S. Department of Agriculture
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.
There are two main non-government mortgage types:
- Conforming loans follow guidelines established by Fannie Mae or Freddie Mac (they get their name because they "conform" to these guidelines). Fannie Mae and Freddie Mac are corporations called government-sponsored enterprises, or GSEs. Both corporations buy mortgages from banks, thrifts and other home loan originators and then sell mortgage-backed securities (like shares of stock) to investors.
- Non-conforming loans do not follow guidelines set by Fannie Mae or Freddie Mac. Their underwriting rules and interest rates can vary a great deal, because the lenders can make their own guidelines as long as they follow federal and state mortgage laws. So-called "jumbo" and "super-jumbo" mortgages are non-conforming products allowing loan amounts that exceed the limits established by the GSEs ($417,000 in most areas, but higher in more expensive locations).
Most conforming and jumbo mortgages require down payments of at least five percent, and borrowers with less than 20 percent down have to purchase private mortgage insurance (PMI). The cost of PMI for the borrower varies, depending on the type of home loan, down payment percentage and credit score. PMI helps many people purchase a home who otherwise would not be able to become homeowners.
There is one product (called My Community Mortgage by Fannie Mae and Home Possible by Freddie Mac) that allows 97 percent financing for first-time buyers who meet income eligibility guidelines. These loans have more flexible underwriting and come with discounted mortgage insurance premiums.
Fixed versus Adjustable Rates
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