Guide to Mortgage Types
When buying or selling your home, it is important to understand the types of mortgages available. As a seller, you want to receive the best financing possible. As a buyer, you want to accept the offer with the highest chance of getting approved for financing. This is your guide to the types of loans available and the most common terms associated with each.
Fixed-Rate and Adjustable-Rate Mortgages
Before we learn about the different types of loans available to buyers, it is crucial to know that most loans are either fixed-rate or adjustable-rate mortgages.
Fixed-Rate Mortgage
A fixed-rate mortgage is one where the interest rate does not change over time. It remains the same for the life of the loan. The rate you lock in at the time you obtain the loan is the interest rate you pay, regardless of what the market does.
Adjustable-Rate Mortgage
An adjustable-rate mortgage (ARM) changes along with market rates. This does not mean that every time interest rates change, yours will. Typically, adjustable-rate mortgages are broken up into time periods and after every time period the interest rate may change based on market fluctuations. For example, the initial interest rate may be set for the first 5 years and then reevaluated based on the market after that. The next time period may be 5 years, after which the interest rate may change again and so on and so forth. Most adjustable-rate mortgages have caps on how much the interest rate can increase over the life of the loan.
Types of Loans
Conventional Loans
The most common financing available are conventional loans. They can either be fixed-rate or adjustable-rate and typically have a loan term of 15, 20, or 30 years. Although eligibility requirements vary from lender to lender, below are the general requirements buyers must meet to obtain a conventional loan.
- Credit score of at least 620
- Proof of consistent income
- Debt-to-income ratio under 43%
- Minimum down payment of 3% (Many lenders prefer a 20% down payment)
If your down payment is less than 20%, you will be required to carry private mortgage insurance (PMI) which is usually packaged with the loan.
FHA Loans
Federal Housing Administration (FHA) loans are designed for buyers who do not meet the qualifications to obtain a conventional loan. Since these are government-backed loans, lenders are able to offer loans with down payments as low as 3.5% and have less stringent eligibility requirements. FHA loans do require borrowers to pay mortgage insurance premiums for the life of the loan. Criteria vary from lender to lender, but the general eligibility requirements are:
- The property must be your primary residence
- Proof of consistent income
- Debt-to-income ratio under 43%
- Minimum credit score (set by lender)
- History free from foreclosure in the past three years
- History free from bankruptcy in the past two years
VA Loans
VA (Department of Veteran Affairs) loans are for those who currently serve in the military, have served, or are a surviving spouse. This type of loan offers lower interest rates, minimal closing costs, and for many, zero down payment. Borrowers do not pay PMI. However, you will have to pay a VA Funding Fee. Lenders set eligibility requirements pertaining to credit score and debt-to-income ratio. Below are the requirements set forth by the Department of Veteran Affairs to qualify for a VA loan.
Borrowers must meet one of the following:
- Serve 90 consecutive days active duty during wartime
- Serve 181 days on active duty during peacetime
- Serve 6 years in the National Guard or Reserves
- Be the surviving spouse of a veteran who passed away while serving or in a related injury
Veterans whose service began after September 7, 1980, or became an officer after October 16, 1981, must meet one of the following requirements:
- Completed their full tour of duty
- 24 months of continuous active duty
USDA Loans
The US Department of Agriculture offers government backed loans in an effort to promote development of rural areas. These loans are geared toward low-to-moderate income buyers and generally require a zero down payment. It is important to note that USDA loans do require borrowers to pay a Guarantee Fee and an annual fee, which both operate similarly to a PMI. All USDA loans are 30-year fixed-rate. As with the previous loans we've discussed, eligibility requirements vary by lender. Below are the basic requirements for borrowers to qualify for a USDA loan.
- Minimum credit score (set by the lender)
- No history of bankruptcy or foreclosure recently
- Meet income requirements (Must not exceed a certain amount, which varies by area)
- Proof of consistent income
- Must be a single-family home
- Property must be your primary residence
- Property but be in an eligible area
Which Loan Type is Right For You?
Above are the four main types of mortgage loans. However, alternative financing options are available for extenuating circumstances. Be sure to check with your lender for more information on all of your options.
When you get ready to sell your home or buy your next home, we are here to walk you through every step of the process.
