Buying a home is an achievement that offers greater financial stability and the opportunity to build wealth — plus the freedom to paint the walls without getting permission from your landlord.
But the process of getting a mortgage loan can be overwhelming, especially since there are so many different types of mortgage loans. In fact, about one third of first-time homebuyers report shedding tears during the homebuying process. Luckily, you can lean on your real estate agent and mortgage loan officer for guidance, and there are plenty of resources available online to help you understand your loan options.
In this article, we’ll go over the basics of the different types of mortgage loans, so you can choose the mortgage that makes the most sense for your household. The best option will depend on what you’re eligible for, your future plans, and current mortgage rates.
Types of Mortgage Loans
Fixed-rate mortgage
With a fixed-rate mortgage, your interest rate and monthly payment stay consistent for the life of the loan. These mortgages are popular when interest rates are low, since they allow borrowers to lock in a low rate. They’re best for homebuyers who want a predictable budget.
Fixed-rate mortgages commonly come in 15-year and 30-year terms. A shorter term means a higher monthly payment but allows you to save money on interest over time.
Fixed-rate mortgages pros and cons
Pros | Cons |
---|---|
• Predictable monthly payments
• Easier to understand and plan for |
• Rates may be higher than with an adjustable-rate mortgage
• Requirements are stricter than with a government-insured loan • To get a lower rate, you must refinance |
Conventional fixed-rate mortgages are more difficult to qualify for than government-insured mortgages. In most cases, you’ll need at least a 620 credit score and a 3% down payment. If you put less than 20% down, you’ll also be required to pay for private mortgage insurance. The same is true for conventional adjustable-rate mortgages.
Adjustable-rate mortgage
With an adjustable-rate mortgage, you’ll make fixed payments during an initial fixed-rate period, and then the interest rate will adjust based on the market. ARMs are popular when interest rates are high, because they offer a lower APR initially, meaning you’ll pay less in interest and fees during the fixed period. Most ARMs also come with rate caps that limit how much your rate can vary during the adjustable period.
The initial period can last six months to ten years. The most common type is a 5/1 ARM, which features a fixed rate for the first five years of the loan. Because ARMs come with unpredictable monthly payments during the adjustable period, they’re best for homebuyers who expect to move or refinance before the initial period has concluded.
Adjustable-rate mortgages pros and cons
Pros | Cons |
---|---|
• Lower initial APR than a fixed-rate mortgage
• Monthly payments could go down if interest rates drop • Rate caps offer some protection from unaffordable monthly payments |
• Unpredictable payments during the adjustable period can be difficult to budget for
• Plans to sell may fall through, and refinancing can be costly |
FHA mortgage
With an FHA mortgage, the Federal Housing Administration insures the mortgage. That makes these loans easier to qualify for with a lower credit score and a down payment as low as 3.5%. FHA loans are a great option for borrowers who don’t qualify for a conventional loan.
However, mortgage insurance premiums are required for homebuyers who put less than 20% down. And unlike private mortgage insurance, you can’t cancel FHA mortgage insurance once you’ve reached 20% equity in your home.
FHA mortgages pros and cons
Pros | Cons |
---|---|
• Looser credit requirements
• Low down payment requirements |
• May come with mortgage insurance premiums lasting between 11 years and the full term |
VA mortgage
With a VA mortgage, the loan is backed by the Department of Veteran Affairs. VA loans are only available to eligible service members, veterans, and their spouses. There’s no down payment required in most cases, no prepayment penalty, and no mortgage insurance requirement. What’s more, VA mortgage borrowers often get access to better rates and fewer closing costs. VA loans require a VA funding fee, however. This fee helps to keep loan costs low for taxpayers. The fee ranges from 1.4% to 3.6% of the loan amount, depending on your down payment and whether you’ve taken out a VA-backed purchase loan before.
VA mortgages pros and cons
Pros | Cons |
---|---|
• No down payment required for conforming loans
• No prepayment penalty • No mortgage insurance |
• Only available to eligible military members and spouses
• VA funding fee required |
USDA mortgage
USDA mortgages are issued or insured by the U.S. Department of Agriculture. They’re only available to borrowers seeking a home loan for a property in an eligible rural area. There are also household income limits that vary depending on the type of USDA mortgage. You can put as little as $0 down with a USDA loan, but a guarantee fee is required for the life of the loan. It works similarly to mortgage insurance. For 2023, the fee is 0.65% of the loan amount upfront and 0.35% of the loan amount annually.
USDA mortgages pros and cons
$726,200, but you can borrow more in high-cost areas. If the home you’re looking to buy exceeds the conforming loan limit in your area, you’ll need a jumbo mortgage. Jumbo loans are more difficult to qualify for than conforming loans.
Jumbo mortgages pros and cons
Pros | Cons |
---|---|
• Can be used to finance an expensive property
• Available in fixed and adjustable-rate options |
• Typically require 10% down
• Stricter credit score requirements |
How to get a mortgage loan
- Get mortgage pre-approval: Once you’ve determined how much house you can afford, you’ll need to get a pre-approval letter from a mortgage lender before making an offer on a house. This will require a hard credit check, and the letter will expire after 30 to 90 days, so you may want to have a specific home in mind. When timing your home purchase, you should also pay attention to housing market predictions.
- Make an offer on a home: Work with your real estate agent to write up an offer for the home of your choice. You’ll include your mortgage pre-approval letter.
- Compare mortgage loan rates: Comparing mortgage rates among lenders helps ensure you get the best rate. Research from Freddie Mac shows borrowers can save an average of $1,500 just by getting one extra rate quote. You’ll have at least two weeks to shop around — during this period, multiple hard credit inquiries will only count as one.
- Formally apply: Choose the lender offering the best rates and terms and begin your formal application.
- Get a home inspection and appraisal: Schedule a home inspection and appraisal. If the inspection reveals problems, you may need to negotiate with the seller. If the home appraises for less than the contracted sale price, you may not be approved for the full loan amount.
- Wait for underwriting: During the underwriting process, you may need to submit additional documents or answer questions. For example, if you have any late payments, you may need to submit letters of explanation. If you’re getting money from a family member, you may need to provide gift letters.
- Close on your new home: On closing day, you’ll sign a stack of documents, receive your keys, and become a homeowner.
Other need-to-know mortgage loan terms
- Annual Percentage Rate (APR): A rate that represents the total cost of your mortgage loan, including the interest rate and origination fee
- Conventional Loan: A mortgage that is not government-insured
- Conforming Loan: A mortgage that meets loan limits for the area
- Debt-to-Income Ratio: A measure of how much debt you have relative your income, which lenders use to assess your eligibility for a mortgage during underwriting
- Equity: The portion of your home you own, or your home’s value less your outstanding mortgage debt
- Interest-Only Mortgage: A type of mortgage that only requires interest payments during an initial period
- Loan-to-Value Ratio: Another way of expressing equity — your outstanding mortgage debt divided by your home’s value
- Mortgage Insurance: A type of insurance that is paid for by the borrower and protects the mortgage lender from the risk of losses due to default
- Prepayment Penalty: A fee that some mortgage lenders may charge if you pay off your loan ahead of schedule
Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.
This article was first published on SFGate.com and reviewed by Jill Slattery, who serves as VP of Content for the Hearst E-Commerce team. Email her at [email protected].
Source: news.google.com