When buying or refinancing a home, you can't choose the best mortgage if you don't know what's available. Just as homebuyers come in all shapes and sizes with varying personal and financial pictures, there is no one-size-fits-all mortgage, says Jason Bonarrigo, a senior loan officer with mortgage banker, RMS Mortgage, in Braintree, MA.
That's a good thing. With just the basic varieties, there are many home loan options to fit many types of buyers.
"If you’re a good candidate for a mortgage, with the proper financial standing and good credit, there is likely to be a mortgage out there that fits you," claims Bonarrigo.
Let's take a look.
Fixed-Rate Mortgage (FRM)
These mortgages come with a fixed interest rate that doesn't change over the life of the loan. That fixed rate allows the borrower to more easily budget homeownership costs. Fixed rate mortgages come with terms ranging from 10 to 40 years, but the most popular and 15 and 30 year loans.
FRMs are the least risky loans and since the mortgage crisis have become the nation's most popular mortgage.
Adjustable-Rate Mortgage (ARM)
To the contrary, an ARM, one of the least popular loans today, carries an adjustable interest rate. That means a borrower's rate and monthly payment can fluctuate during the life of the loan.
At the onset, the rate is likely lower than a FRM for the same amount. However, depending upon changes in the financial market that drives financial market indexes up and down, mortgage interest rates can likewise rise or fall.
"ARMs that change after the first month or year, especially in a rising interest rate market are most risky," says Bonarrigo.
Less risky hybrid ARMs are fixed for a period (typically three, five or seven years) and then become full-fledged ARMs that can move up or down. ARMs and hybrid ARMs do have some features that can make them safer. Interest rate caps limit the amount that the rate can be increased when adjusted, and lifetime caps restrict the interest rate over the life of the loan. If, for example, your ARM has a start rate of three percent and a lifetime cap of six (which is pretty common), the highest the rate can ever go is nine percent (6% + 3%).
A conventional mortgage is not insured by the government. Most loans that are not FHA, VA or rural housing mortgages are conventional loans. Conventional loans can be either fixed or adjustable.
These loans are eligible for purchase by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). They are called "conforming mortgages" because they must all conform to the same guidelines. One such guideline is a cap on the loan amount.
These loans are larger than conforming loans. They are also referred to as "non-conforming" loans, and they may carry higher rates. "Because these loans are a higher risk for lenders, they generally carry a higher mortgage rate for the borrower," asserts Bonarrigo. Because jumbo mortgages don't have to conform to the requirements of Fannie Mae or Freddie Mac, lenders can make up their own requirements for these products. Hence, you will see more variation in pricing and underwriting than you will with conforming loans.
There are several government loan programs including Federal Housing Administration (FHA), Veterans Affairs (VA) and USDA (Rural Housing) mortgages. The purpose of government loans is to make home ownership available to more people. These loans are for purchasing primary residences at moderate prices -- not mansions or vacation homes.
The government does not provide FHA and VA loans. They are secured through private lenders and are federally guaranteed. The government backs USDA loans under its guaranty program and it actually lends the money under its direct lending program. Federal backing means the government picks up the cost if you default on the loan and lose your home.
Government loans are often assumable and offer more flexible underwriting.
FHA mortgages are not just for first-time buyers and there are no income restrictions. They require down payments of 3.5 to ten percent, depending on the borrower's credit score. FHA loans can be used to build, buy or rehabilitate property.
VA loans are available to active servicemembers, veterans and certain members of their families. They require no down payment. To apply for a VA mortgage, you must first obtain your Certificate of Eligibility. This can be done online in most cases. Your lender can also help you get your certificate.
Rural Housing Mortgage
You don't have to live on a farm to obtain a home loan from the U.S. Department of Agriculture's (USDA) Rural Development program. These loans require no down payment. They can even offer subsidized interest rates to those with low- to very-low incomes.
USDA loans can be used to purchase or refinance properties in eligible rural areas, based in part on population densities. In fact, about half the population in the US lives in areas designated as "rural" by the government.
Loans for Other Purposes
There are loans to buy or refinance just about any kind of property. Said Bonarrigo, "There are additional loans available for specialized buyers. Some need a bridge loan, others a construction or rehab loan and still others a reverse mortgage."
"If your needs fall outside the most common types of loans, check with your online resources, your real estate agent, mortgage broker, mortgage banker, bank loan officers or financial planner to set you on the right path."