In this article, you will learn:
- The two categories of home loans.
- The five main types of mortgage loans.
- Other possible options for home loans.
- How to get personalized help choosing a home loan.
2 Major Categories of Home Loans
Mortgage loans generally fall into one of two categories:
- Fixed-rate mortgage loans
- Adjustable-rate mortgage loans
With a fixed-rate mortgage, the interest rate remains unchanged for the entire term of the loan. In a 30-year fixed mortgage, for example, the interest rate would remain the same for the whole 30 years (unless the loan was refinanced to a new loan or the home was sold before the end of the loan term).
The primary benefit of a fixed-rate mortgage is that you know exactly what your interest rate will be throughout your loan. If you lock in your rate while rates are low, you can potentially save a lot of money over the term of your loan. If mortgage interest rates decrease during the term of your fixed-rate mortgage, you may be able to refinance to get the lower rate.
With an adjustable-rate mortgage (also referred to as ARMs), the interest rate fluctuates along with market rates at different points during the loan term. ARMs can be structured using different time frames, for example starting with an initial rate that remains unchanged for a period of five or ten years and then fluctuating after that initial period.
The primary benefit of most ARMs is that the initial interest rate is typically lower than the interest rate for a fixed-rate mortgage. Because the rate typically changes with the market, it is possible for the rate to go down, but it is also possible for the rate to go up. The borrower carries the risk of potential future increases, although some lenders cap the rate increases.
The 5 Main Types of Home Mortgage Loans
There are five main types of mortgages:
- Conventional mortgages
- Jumbo loans
- FHA loans
- VA loans
- USDA loans
1. Conventional Mortgages
A conventional mortgage is any mortgage that is not backed by the government (we’ll discuss government-backed loans shortly). Conventional loans are the most common mortgage loan type in America.
Conventional home loans can be either fixed-rate or adjustable-rate. Terms of 10, 15, 20 and 30 years are common. A conventional loan can be either conforming (in which the loan meets industry standards for packaging loans into securities that can be traded on the stock market) or nonconforming (in which the loan does not meet industry standards for bundling into securities).
As with all types of mortgage loans, the criteria for qualifying for a conventional loan vary by lender. Having said that, here are the general requirements for a conventional loan:
- Good credit
- A down payment of at least 3%
- A manageable debt-to-income ratio
- Private mortgage insurance (PMI) for loans with a down payment under 20%
2. Jumbo Loans
Jumbo loans are loans that exceed the loan maximums set by Fannie Mae, Freddie Mac and the Federal Housing Finance Agency. Because these loans exceed the maximums set by these agencies, these agencies cannot buy them from the loan originators. This means that the originator is taking a greater risk by lending an amount this large. Because of this increased risk, jumbo loans may have more strict qualifying criteria and/or higher interest rates.
3. FHA Loans
FHA loans are government-backed loans, in which the FHA (Federal Housing Administration) insures a portion of the loan. This program was designed to make homeownership accessible for buyers who don’t meet the requirements to qualify for a conventional loan. By insuring the loan against borrower default, the FHA enables lenders to offer down payments as low as 3.5%, with potentially lower closing costs and more flexible qualification requirements. Keep in mind that FHA loans require payment of mortgage insurance premiums.
4. VA Loans
- Direct, in which the VA lends directly to the borrower, or
- Guaranteed, in which the VA secures the loan from a third-party lender.
VA loans offer lower interest rates, limited closing costs and the potential for qualified buyers to get a loan with zero down payment and no PMI. However, VA loans require payment of a VA Funding Fee.
5. USDA Loans
USDA loans are government-backed loans that encourage low-to-moderate-income buyers to consider homes in areas with lower population density. In an effort to promote the development of rural areas, the US Department of Agriculture (USDA) offers two USDA loan options:
- Direct loans, in which the USDA lends money to borrowers directly and
- Guaranteed loans, in which the USDA secures loans from third-party lenders on behalf of borrowers.
The main benefit of USDA loans is the opportunity for qualified buyers to purchase a qualified home with zero down payment. However, USDA loans require an upfront Guarantee Fee as well as an annual fee, which is similar to a conventional loan’s PMI.
Are There Other Types of Mortgages Available?
The five mortgages we’ve just discussed may be the main types of mortgage loans, but they aren’t the only home loan options available for borrowers. Here are a few of the other types of mortgages you may come across.
- Home equity loans. Home equity loans are second mortgages, which allow homeowners to borrow against the equity in their homes.
- Reverse mortgages. Reverse mortgages allow senior citizens to convert a portion of their home equity into income each month.
- Construction loans. Construction loans help property owners cover the cost of developing raw land or renovating an existing structure.
- Interest-only loans. Interest-only loans allow qualified borrowers to maintain lower monthly payments by excluding the principal loan balance from the initial mortgage payments. Instead, payments are applied only to the interest for the first several years of the loan.
- Balloon mortgages. Balloon mortgages carry comparatively low monthly mortgage payments, followed by a single, large payment at the end of the loan. Balloon mortgages can be used by borrowers who plan to refinance or sell the property before the balloon payment is due.
With so many different types of home loans available, it is wise to speak with a lender about the options for your unique circumstances and goals. Contact the financial experts at PNC Bank for a free home loan consultation.