You’re ready to buy a home – but do you know what type of loan you need to move into that perfect property? There are many different types of mortgage loans and each one offers a unique set of advantages.
We’ll take a look at six of the most common mortgage types and who should get them.
Fixed-Rate Conventional Loan
Who’s it for? Home buyers with a solid financial profile who want a consistent and predictable monthly payment.
Fixed-rate conventional mortgages are the most common type of home loan. Unlike other types of mortgage loans, you can use a conventional mortgage to buy most types of residential properties.
Conventional loans have stricter credit score and debt-to-income ratio qualifications. You need a credit score of at least 620 points and your DTI ratio should be less than or equal to 50% to qualify for a loan with most mortgage lenders.
Many home shoppers believe that they need at least a 20% down payment to buy a home with a conventional loan. This isn’t true – it’s possible to get a conventional mortgage with as little as 3% down. However, if you have less than 20% down when you close on your loan, your lender requires you to pay private mortgage insurance. PMI is a type of insurance that protects your lender if you default on your loan – but it offers you no protection. The good news is that you can cancel PMI once you reach 20% equity in your home.
Fixed-rate conventional loans keep the same interest rate throughout the entirety of the loan. Once you lock in your interest rate, it won’t change, even if market rates go up or down. This also means that your monthly payment will stay the same each month.
Adjustable Rate Mortgage (ARM)
Who’s it for? Buyers who purchase a home that they plan to move out of within a few years or who plan to pay off their loan early.
An ARM is a type of conventional loan with a slightly more complicated interest structure. ARMs begin with an initial fixed-interest period. The fixed-rate period might be as short as 5 years or as long as 10 years, depending on your lender. During this period, you’ll have access to a fixed rate that’s lower than current market rates. After the initial period ends, your interest rate will rise or fall, depending on how current market interest rates move.
ARM loans include rate caps that limit how much your interest can rise (or fall) over the course of your loan. Your loan will include a rate cap for each year and a rate cap during the lifetime of the loan. Rate caps protect you from interest rates that rise year after year. For example, let’s say your loan has a rate cap of 7% and your interest rate has already risen to 7%. It won’t rise any further, even if market rates continue to rise. Rate caps also prevent your interest rate from falling too low.
You’ll need to meet the same credit and income standards as a fixed-rate conventional loan to qualify for an ARM. ARMs can be beneficial if you plan to pay down your loan early or you know that you won’t stay in your home for more than a few years. Taking an ARM can also be a good choice if market interest rates are particularly high when you want to buy.
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Who’s it for? Residents who want to buy a home in a rural or suburban area and who have a low down payment.
The USDA loan is a type of government-backed mortgage. Because of this, these types of loans are less risky for lenders so they can issue them to buyers with lower financial and credit requirements. However, to qualify for a government-backed loan, both you and your home will need to meet the loan’s unique standards.
A USDA loan can allow you to buy a home with $0 down. Even if you have no down payment, you won’t have to pay for PMI like you would with a conventional loan. Instead, you’ll pay a guarantee fee that’s more affordable. You may even have the option to roll your guarantee fee and closing costs into the principal balance of your loan.
USDA loans are for home buyers who live in rural or suburban areas. You need to buy a house in an approved rural area to qualify for a USDA loan. You can use the USDA’s property eligibility page to see if the home you want to purchase qualifies. You must also have a credit score of at least 640 points, and you must meet the USDA’s income standards for your area. To see if your income qualifies you for a USDA loan, use the USDA’s income eligibility calculator.
Your property must also meet the USDA’s livability standards to qualify. Your home must be your primary residence – you cannot buy an investment property or vacation home with a USDA loan. Your property also cannot be a working farm and it must be in livable condition. For example, you cannot buy a home with a nonfunctional water system using a USDA loan.
Who’s it for? Former and current members of the military who want to buy a home with a lower down payment.
VA loans are another type of government-backed loan. VA loans are for veterans, active members of the armed forces and select surviving spouses. A VA loan can allow you to buy a home with no money down and you can also avoid PMI payments. You’ll need to pay a small VA funding fee when you get your loan but select veterans may be able to get a waiver to remove the fee. VA loans also have lower interest rates than comparable government-backed loans, which can make them even more affordable.
To qualify for a VA loan, you must meet service requirements. Any one of the following statements must be true before you can get a VA loan:
- You’ve served 90 consecutive days of active military duty during wartime.
- You’ve served 181 consecutive days of active military duty during peacetime.
- You’ve been an active member of the National Guard or Reserves for at least 6 years.
- You’re the surviving spouse of a service member who lost their life in the line of duty or as a consequence of a service-related injury.
You or your spouse must move into your new property within 60 days of closing to use a VA loan to buy a home. There are exceptions to this – for example, you may be deployed and unable to move in during that time. You must also buy a primary residence with your loan. You cannot use a VA loan to buy a second home or investment property.
Who’s it for? Buyers who want to buy a home with a low credit score.
The final type of government-backed loan, an FHA loan, can help you buy a home when you have a lower credit score. Unlike VA and USDA loans, you do need to put at least 3.5% down on your home to qualify for an FHA loan. However, you can get an FHA loan with a credit score as low as 580 points. Let’s say you have at least a 10% down payment. You may even be able to get a loan with a credit score as low as 500 points (however, 580 is the minimum score at Rocket Mortgage®). You must buy a primary residence with your FHA loan.
With an FHA loan, you need to pay an upfront mortgage insurance premium as well as a monthly MIP payment. Unlike PMI, you cannot cancel your MIP payments – they stick with you until you make the last payment on your loan unless you make a down payment of at least 10%, in which case MIP will be on your loan for 11 years. Many homeowners refinance their FHA loans into conventional mortgages once they reach 20% equity in their property.
Who’s it for? Anyone who wants to buy a property that goes above conventional loan limits.
Most mortgages are conforming mortgage loans. A conforming loan means that a loan meets the minimum standards for purchase by Fannie Mae and Freddie Mac. Fannie and Freddie are mortgage investment companies. Most lenders sell their mortgage loans to Fannie or Freddie shortly after closing. This frees up cash flow and allows lenders to continue issuing loans.
A loan must be at or below a certain dollar amount to conform. In most parts of the country, the conforming limit is $484,350. If you want to buy a home that’s more expensive than that, you’ll need a jumbo loan.
A jumbo loan is a high-value loan that exceeds conforming loan limits, but jumbo loans usually have comparable interest rates to conforming loans. The amount that you can get in a jumbo loan varies by lender. For example, if you get a jumbo loan through Quicken Loans, you can borrow up to $3 million for your home purchase.
Jumbo loans are much riskier for lenders than conforming loans. In most cases, you’ll need at least 10% down to qualify. Lenders will carefully look at your finances and cash reserves before they give you a loan. Your lender may require you to have up to 18 months of mortgage payments in your savings account before you can get a loan. You’ll also need a higher credit score compared to other loan types.
There are multiple types of mortgage loans. The best loan for you will depend on your unique circumstances. If you need a standard and predictable monthly payment, a fixed-rate conventional mortgage might be right for you. You may prefer an ARM if you want to pay off your loan early. You might also need to get a jumbo loan if you want to buy a very expensive property.
Government-backed mortgages can make homeownership more affordable. FHA loans can allow you to buy a home with a lower credit score. If you’re a member of the armed forces, a VA loan can allow you to buy a home with $0 down. Buying a home in a rural area? A USDA loan might be right for you.
If you aren’t sure what type of loan is best for you, contact a Home Loan Expert. They’ll take a look at your individual situation and help you make the right choice.
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