Mortgage Loans: The 7 Types You Need to Know

There are several types of mortgage loans that you can get to purchase or refinance your home. Learn what they are and how they differ.

1. Conventional loan

A conventional loan or conventional mortgage is a home loan that’s not insured or backed by the federal government. Instead, it’s available through private lenders, such as banks, credit unions, and mortgage companies.

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With conventional loans, most lenders will require you to pay for private mortgage insurance (PMI) if your down payment is less than 20% of the purchase price.

It protects the lender if you stop making payments on your loan and is most commonly added to your monthly payment.

Most conventional mortgage loans will have a fixed interest rate, meaning it won’t change for the life of your home loan.

There are two types of conventional loans, conforming and non-conforming.

A conforming conventional loan is one that falls under the maximum limit set by Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corporation). The limits are adjusted every year based on housing price changes.

If your mortgage is higher than the limit, it’s considered a non-conforming loan, which is also known as a jumbo loan.

Non-conforming loans are considered riskier for lenders because they aren’t guaranteed by Fannie Mae or Freddie Mac.

This may result in a higher interest rate, closing costs, fees, cash reserves, and larger down payments.

2. Adjustable-rate mortgage (ARM)

The outstanding balance of an adjustable-rate mortgage has an interest rate that changes based on market conditions. Initially, the interest rate is fixed for a set period before it begins to change.

There are different types of adjustable-rate mortgages, and they’re represented by two numbers. The first number indicates how long the fixed interest rate will be in effect, and the second shows how many times the rate will change each year.

The following are common types of adjustable-rate mortgages with 30-year terms:

• 5/1 ARM. The first 5 years have a fixed interest rate, and the interest rate will adjust annually for the remaining 25 years.
• 7/1 ARM. The first 7 years have a fixed interest rate, and the interest rate will adjust annually for the remaining 23 years.
• 10/1 ARM. The first 10 years have a fixed interest rate, and the interest rate will adjust annually for the remaining 20 years.

After the initial fixed-rate period, the interest rate will adjust based on an index plus a set margin.

Although an adjustable-rate mortgage can put you at risk for higher interest rates, monthly payments, and falling housing prices, it can also be beneficial.

If you’re planning to sell your home or pay it off within the fixed-rate period, you may benefit from a lower rate.

3. Interest-only mortgage

An interest-only mortgage is a type of home loan where your monthly payment only covers interest. Usually, this is done for the first five or ten years of getting the loan.

The benefit of getting an interest-only mortgage is that your monthly payment is lower because you’re only paying for the interest.

The downside is that you’re not paying down any of the principal. If you choose to make principal payments, you still can.

Interest-only mortgages are structured like adjustable-rate mortgages. There’s an initial period to make monthly interest payments. Then, the interest rate will adjust based on market conditions.

You can also get an interest-only mortgage with a fixed rate. However, they’re not as common as ones with a variable rate.

4. Reverse mortgage

If you’re 62-years-old or older and have a good amount of equity in your home, you can get a reverse mortgage for any of the following reasons:

• Supplement your income.
• Pay for large expenses.
• Pay off your mortgage.

Instead of making monthly payments, the outstanding balance when you get a reverse mortgage is due when you sell your home, no longer live at that home as your primary residence, or pass away.

Although you aren’t required to make a monthly payment, interest is being added to your balance every month, which can add up.

The interest that’s added isn’t tax-deductible either. Keep that in mind before you get a reverse mortgage.

5. FHA loan

An FHA loan is a mortgage that’s insured by the U.S. Federal Housing Administration. It’s a type of federal assistance, and you can only get one from an FHA-approved lender.

The program is designed for low and moderate-income borrowers with lower credit scores.

It also requires a smaller down payment of 3.5% or 10% based on your credit score. To qualify for the 3.5% down payment, your credit score must be at least 580.

With FHA loans, you’re required to pay for FHA Mortgage Insurance Premium (MIP). There are two premiums, one that you’ll pay upfront, and the other is included in your monthly payment.

If you aren’t able to pay the upfront premium, you can roll it into your monthly payment, which will increase it.

Remember, the FHA does not originate loans, it only insures them. Your mortgage will be from an FHA-approved lender.

6. VA loan

A VA loan is a mortgage that’s guaranteed by the U.S. Department of Veterans Affairs (VA).

The loan is provided by private lenders, such as banks, credit unions, and mortgage companies. However, the VA backs a portion of the loan, which allows you to get better terms.

Two of the main benefits of a VA loan are that you aren’t required to make a down payment or get private mortgage insurance.

If you decide to get a VA loan, you’ll need a Certificate of Eligibility (COE). You’ll provide it to mortgage lenders to show that you qualify for a VA loan. You can get a COE through the VA website, by mail, or through the lender.

7. USDA home loan

USDA home loans are mortgage loans that are backed by the U.S. Department of Agriculture. It’s also known as the USDA Rural Development Guaranteed Housing Loan Program.

If you meet the income requirements and want to purchase a home in an eligible rural area as defined by USDA, you may be able to get a USDA home loan. Your credit score must also be at least 640.

The benefits of getting a USDA home loan are that you don’t have to make a down payment and low-interest rates.

Frequently asked questions

Conclusion

If you’re planning to buy a home, learning about the different types of mortgages will help you find the best home loan for your situation. Talk to a mortgage advisor to figure out which is best for you.

More resources:

• Understanding the Loan-to-Value (LTV) ratio
• What’s a Home Equity Line of Credit (HELOC)?
• The ultimate guide to Annual Percentage Rate (APR)

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