Keeping up with the different types of mortgages can be confusing. Fortunately, we’ve got you covered.
When you’re ready to buy a house, it’s a good idea to go into your dealings with a lender with a solid idea of what types of mortgages are available to you and the pros and cons of each. Depending on your financial situation, your future plans, and your reason for buying the house, the loan that best suits you may be completely different from what you were expecting. Here, we’ll break down six different types of loans: Fixed Rate, Adjustable Rate, Conventional, Government Insured, Conforming, and Non-Conforming—and dive into the advantages and disadvantages of each.
When you’re ready to buy a house, it’s a good idea to go into your dealings with a lender with a solid idea of what types of mortgages are available to you and the pros and cons of each.
FIXED-RATE LOANS VS. ADJUSTABLE-RATE LOANS
The difference between a fixed-rate loan and an adjustable-rate loan is pretty simple. They’re both pretty much what their names imply. When you choose a fixed-rate mortgage loan, the interest is fixed for the entire life of the loan, locking you in at a set interest rate. The length of the loan can vary, but the two most common terms are 15 and 30 years. One of the advantages of a fixed-rate mortgage loan is that you know what your monthly payment will be for the duration of the loan. This makes it easier to budget and plan for months in advance. The downside is that if you take out a loan while interest rates are high, you’re locked into that rate for the life of the loan. Although you may be able to refinance, be mindful that it’s not guaranteed.
Adjustable-rate mortgages, also known as ARMs, have interest rates that change throughout the life of the loan as interest rates fluctuate. ARMs usually have a fixed-rate period at the beginning that lasts between five and 10 years. After that, the rate switches to variable. The variable rate is typically set using a benchmark index rate that is based on market conditions and fluctuates from month to month. The advantage of a variable interest rate on a loan is you won’t be locked into a high rate for the life of your loan. On the other hand, this makes it tougher to budget and interest rates can rise over the years just as easily as they can fall, opening up the possibility of having a higher interest rate than you would with a fixed-rate loan.
CONVENTIONAL LOANS VS. GOVERNMENT-INSURED LOANS
A Conventional loan is originated by a bank or private lender and is not insured by a government agency. Lenders will look long and hard at credit scores, debt-to-income ratios, and financial history in evaluating Conventional loan applications. A down payment of at least 3% is usually required, but you may opt to pay more in order to decrease your mortgage payments down the road. Since these loans aren’t insured by a government agency, you’ll likely have to purchase private mortgage insurance if your down payment is less than 20%.
If you’re looking for more lenient lending standards, government-insured loans like FHA and VA loans may be right up your alley. These loans tend to be more flexible than Conventional loans, accepting lower credit scores and smaller down payments. Insured by the Federal Housing Association, FHA loans could be a good choice for you if your financial history is less-than-stellar. VA loans typically don’t require a down payment at all, but they are only available to veterans, active-duty servicemembers, and surviving spouses.
CONFORMING LOANS VS. NON-CONFORMING LOANS
A conforming loan is one that meets certain guidelines established by the Federal Housing Finance Agency, also known as the FHFA. The amount you can borrow is limited, and that limit changes every year based on FHFA guidelines. Conforming loans offer better interest rates and lower fees than non-conforming loans.
While there are several types of non-conforming loans, the most common is a Jumbo loan. As their name implies, Jumbo loans exceed the limited borrowing amount of a conforming loan. Because of the size of the loan, the requirements to qualify are a lot more strict, and interest rates are usually higher because they are considered more of a risk to the lender. There are other types of non-conforming loans for borrowers with bad credit, high debt-to-income ratio, and borrowers who have filed for bankruptcy.
Knowing the different types of mortgage loans that are available to you is a key tool in ensuring that you receive the best possible loan for your situation. There’s not one type of loan that’s “better” than any of the others—it all depends on your situation. Do your homework and speak to a mortgage expert to find out how each of these types of loans applies to your specific situation so you can make the best possible decision.