Buying a home is an investment many people spend years saving up for. However, deciding which mortgage is best for you can be overwhelming. How do you choose which loan is the best for you and your financial future?
Here are the five types of home mortgages and which may be right for you.
Conventional Mortgage
There are two types of conventional mortgages, otherwise known as home loans that aren’t insured by the federal government: conforming and non-conforming loans.
A conforming loan falls within the maximum federal loan limits that are set by Fannie Mae or Freddie Mac, which are government-sponsored enterprises that back most mortgages in the U.S. Non-conforming loans are simply the mortgages that don’t follow these set limits.
Generally, conventional loans are best for people with strong credit, a stable income and employment history and a down payment of at least 3 percent.
Pros of a Conventional Mortgage
- Can be used for a primary home, second home or investment property
- Borrowing costs are often lower than other types of mortgages, even if interest rates are higher
- Your lender can cancel PMI once you’ve gained 20 percent equity
- Pay only 3 percent down for loans backed by Fannie Mae or Freddie Mac
Cons of a Conventional Mortgage
- You often need a minimum FICO score of 620 or higher
- Must have a debt-to-income ratio of 45 to 50 percent
- Likely to pay PMI if your down payment is less than 20 percent of the sales price
- Hefty documentation required to verify income, assets, down payment and employment
Jumbo Mortgages
Jumbo mortgages are a type of non-conforming conventional loan, which means the home prices tend to exceed the federal loan limit. In 2020, the highest conforming loan limit for a single-family home in the U.S. is $510,400. However, in more expensive areas of the country, where jumbo mortgages tend to be more common, the limit is $765,600.
Jumbo mortgages benefit buyers who have strong credit, a high income and a generous down payment.
Pros of a Jumbo Mortgage
- Can borrow more money to buy a home in an expensive area
Cons of a Jumbo Mortgage
- You need a down payment of at least 10 to 20 percent
- Need a FICO score of 700 or higher. However, some lenders may accept a minimum score of 660
- You cannot have a debt-to-income ratio higher than 45 percent
- You need to show you have significant assets (generally 10 percent of the loan amount) in cash or savings account
Government-Insured Mortgages
FHA Loans
Insured by the Federal Housing Administration, this type of loan is perfect for buyers who don’t have a lot saved up for a down payment and have less-than-stellar credit. All you need is a FICO score of at least 580 to receive the FHA’s maximum financing of 96.5 percent and a 3.5 percent down payment. However, a FICO score of 500 is accepted if you put 10 percent down.
USDA Loans
This loan is backed by the U.S. Department of Agriculture, which means it’s most fitting for moderate- to low-income people who are buying a home in a USDA-eligible area.
VA Loans
For members of the U.S. military (active or veterans) and their families, the Department of Veteran Affairs provides loans that are flexible and have low interest rates. These loans don’t require a down payment or PMI, and the closing cost of the home has a limit and may be paid by the seller.
Government-insured loans are best for buyers who don’t have much in savings, low credit and can’t qualify for a conventional loan.
Pros of Government-Insured Mortgages
- Requirements are relaxed
- Don’t need a large down payment
- Open to repeat and first-time buyers
Cons of Government-Insured Mortgages
- On some loans, you may need to pay mandatory mortgage insurance premiums that cannot be canceled
- Higher borrowing costs
- Hefty documentation, depending on the loan type
Fixed-Rate Mortgages
As the name suggests, having a fixed-rate mortgage means your monthly payment will stay the same until the loan is fully paid off. Typically, these loans come in terms of 15, 20 or 30 years.
If you plan on staying in your home for more than seven years, fixed-rate mortgages can bring you stability with your monthly payments.
Pros of Fixed-Rate Mortgages
- Your monthly principal and interest payments remain the same throughout the full loan term
- Easier to budget your monthly costs
Cons of Fixed Rate Mortgages
- Pay more interest with a long-term loan
- Takes you longer to build your home’s equity
- Interest rates are higher than rates on adjustable-rate mortgages
Adjustable-Rate Mortgages
In contrast to the stability of fixed-rate mortgages, adjustable-rate mortgages have changing interest rates that go up or down, depending on the market. Many AR mortgages have a fixed rate for the first few years but will then switch to a variable interest rate for the rest of the term.
With AR mortgages comes risk. They can save you loads on interest payments, if you plan on staying in your home for only a couple of years.
Pros of Adjustable-Rate Mortgages
- Lower fixed rate in the first couple of years of homeownership
- Save a significant amount of money on your interest payments
Cons of Adjustable-Rate Mortgages
- Monthly mortgage payments could become too expensive for you to pay off
- Your home’s value may fall in a few years, which would make it difficult to refinance or sell your home before the loan resets
If you’re looking to buy a home, our real estate experts are here to help. CENTURY 21 Semiao & Associates will answer all of your questions and guide you through the process of deciding which mortgage may be best for you and your future. For more housing tips, check out our blog!
