Buying your own house is one of the biggest steps you would take in your life and towards your future. There are a number of loan types available in the market and it is a decision better taken well informed. This post offers some brief information about mortgage types available that you can consider when deciding. Look for hyperlinks to read topics in detail.
When considering mortgages, there are a number of options available, however, here, for keeping it simple, we have narrowed down them all to the below mentioned options.
Adjustable Rate OR Fixed Rate
First choice that a borrower has to make while considering mortgages is whether you want an adjustable rate or a fixed rate mortgage loan. Most of all loans belong either of these two. Let us see what these are.
- Fixed-rate as the name suggests, has a fixed rate of interest for the entire term of the loan. Throughout the period of loan repayment, this keeps the amount of your monthly payment same. It will never change. Even in case of a long term financing option, like a 30 year fixed rate loan, this remains true and monthly payment is same for the entire term.’
- Adjustable-rate mortgages (ARMs) have a variable interest rate that would change time and again. Usually, applied interest rate on an ARM changes every year after remaining fixed for an initial period. As an example, the rate of interest in a 5/1 ARM would remain fixed for the five years in beginning and after that it would start to adjust every1 year, i.e., annually.
ARMs are therefore also referred to as a hybrid because it starts off with a fixed or unchanging interest rate, before switching over to an adjustable rate.
Certainly, both have some pros and cons with them. Differences in the Fixed Rate and Adjustable Rate Mortgage are:
The ARM kicks off with an interest rate that is lower compared to a fixed rate mortgage. However, interest rate and monthly payments of an such a loan can go up over time.
Never changing interest rates and monthly payments are the prime benefit of a fixed rate loan. However, when compared to initial rate for an ARM, the stability is paid for through higher interest rates
Government-Insured vs. Conventional Loan
Other than choosing between the fixed rate and adjustable rate mortgages as explained above, one also has to choose whether to opt for a government-insured home loan (like FHA or VA) or a “regular” conventional type of mortgage. Let’s see how these two types of mortgage are different.
A mortgage that is not insured or guaranteed by the federal government in any way is a conventional home loan. This makes it different from the below three mortgage types backed by the government (FHA, VA and USDA).
HUD, the Department of Housing and Urban Development, manages the Federal Housing Administration (FHA) mortgage insurance program. Not just to the first time buyers, all types of buyers can benefit from these. Lender is insured by the government against the possible losses that may be a result of buyer default.
Under this program, the borrower is allowed to make a down payment of as low as 3.5% of the purchase price.
Disadvantage: Monthly payments increase because the mortgage insurance adds up to the amount.
Military service members and their families are offered a home loan program by The U.S. Department of Veterans Affairs (VA). The federal government, just like the FHA, guarantees this type of loans. This means, any losses caused due to borrower default will be reimbursed, by the federal government.
Advantage: 100% financing can be availed for purchasing a home, by the borrower. No down payment at all!
Disadvantage: Interest paid
overall goes up as there is no or very low down payment.
USDA / RHS Loans
Rural borrowers, meeting some set income requirements are offered a mortgage loan program by USDA(The United States Department of Agriculture) (USDA). RHS(the Rural Housing Service), a part of Department of Agriculture, manages this program. Rural residents with income being steady, low and modest but incapable of attaining satisfactory housing through the means of conventional mortgage are offered this type of mortgage. To be eligible for this program, income should be less than or equal to 115% of the adjusted AMI(area median income), which varies by county
Important note: Mortgage types explained above can be combined by the borrowers. Let’s say as an example, Borrower may choose an FHA loan with an adjustable rate(ARM) or probably a conventional home loan with fixed interest rate.
Jumbo vs. Conforming Loan
Based on the size of the loan, there is another distinction can be made while discussing types of loans. As per the amount that is being borrowed by the borrower, the loan might into either of the below mentioned categories. Here is what these are and how they differ:
- A Conforming loan :
When it comes to the loan size concerns, a Conforming Loan is one that meets the underwriting guidelines of Fannie Mae or Freddie Mac. Fannie and Freddie are two corporations controlled by the government and are into sale and purchase of MBSs (mortgage-backed securities). Basically, lenders generate loans and sells to them; they then further sell them via Wall Street, to investors. A conforming loan falls within their maximum size limits, and otherwise “conforms” to pre-established criteria.
- A Jumbo loan:
Compared to conforming loans, a Jumbo Loan, exceeds the limits established by Fannie and Freddie. Due to its size, this type of loan involves higher risk for the lender. Jumbo borrowers, therefore, must have large down payments as well as excellent credit. Also, the interest rates are generally higher with the jumbo products.