Popular Types of Mortgage Loans Explained
If you’re thinking of buying a home, choosing the right type of mortgage is an important decision. When considering your options, it is essential that you fully understand the differences between each type of mortgage available. Here we discuss eight of the most popular mortgage types to help you make the best decision for your home-buying journey.
What Is a Mortgage?
In its simplest form, a mortgage is a specific loan type that a lender grants a borrower to purchase a home. That home is used as collateral to secure the loan, which keeps the rates a bit lower than many other common loan types. There are several types of mortgages, each designed to meet the specific needs of would-be homeowners.
Common Mortgage Lender Terms
Lenders generally categorize mortgages into four subsets. It’s important to understand these before delving into more specific loan types, so let’s start by taking a high-level approach to how lenders structure mortgages.
Conventional Mortgages
Conventional mortgages are those which are not backed or guaranteed by the government. These types of mortgages tend to carry a fixed interest rate with stricter lending requirements for borrowers.
Non-Conventional Mortgages
Commonly referred to as government-backed mortgages, non-conventional mortgages are guaranteed, at least in part, by a governing entity – even if a borrower defaults. Some of the most common non-conventional mortgages include FHA, VA, and USDA mortgages.
Conforming Mortgages
Conforming mortgages meet all guidelines of a government-sponsored enterprise (GSE) such as Fannie Mae or Freddie Mac. GSEs purchase mortgages from lenders and package them to create mortgage-backed securities.
Pro-Tip: All conforming loans are conventional, but there are times when a conventional loan is not a conforming loan. Make sure you thoroughly and completely understand your loan’s terms when discussing a mortgage with a lender.
Non-Conforming Mortgages
Non-conforming mortgages are loans that do not meet GSE guidelines. These mortgages are generally more difficult to secure, so they require a higher interest rate or down payment for the borrower to qualify.
Why Your Type of Mortgage Matters
While it may seem arbitrary to an uninformed borrower, the type of mortgage loan for which you may qualify can have a significant impact on several key factors.
- Down payment required
- Interest rate offered
- Monthly payment
- Additional fees, such as private mortgage insurance (PMI)
- Closing costs
Because there is so much at stake, choosing a reliable lender is crucial – especially for first-time homebuyers. It’s best to find someone who takes the time to adequately explain your options and help you understand them well.
Pro-Tip: It’s fairly rare for a homebuyer to be restricted to a single type of mortgage when they’re looking to purchase a home. When meeting with prospective lenders, be up front with information about your income, your credit score, and what you have for a down payment. As you share, pay attention to how they use that information to get a feel for whether they’re truly working toward putting you in the best long-term position.
Most Popular Types of Mortgages
Here we look more closely at eight popular types of mortgages and compare them.
1: Fixed-Rate Mortgage
With a fixed-rate mortgage, the interest rate will never change. You will know exactly how much interest you will pay over the loan term, and you will not have to worry about fluctuations in the interest rate driving up your monthly payment. Over the course of your loan term, changing property taxes and homeowners insurance may still cause slight fluctuations in your monthly payment.
The conventional 30-year fixed-rate mortgage is the most popular type of home loan in the U.S., but it does require a good credit score. Lenders may require that some borrowers make a down payment of 20% or more to qualify for this loan, but that keeps monthly payments down by eliminating compulsory PMI. A fixed-rate mortgage is generally the choice for homebuyers who desire lower monthly payments and predictable interest rates.
Pro-Tip: If considering a fixed-rate mortgage, weigh your personal budget carefully to determine if you can afford the payments on a 15-year term as opposed to the 30-year alternative. The benefits are that the interest rate will likely be a bit lower, the loan will be paid off in half the time, and that you will be able to build equity in your home more quickly.
2: Adjustable-Rate Mortgage
An adjustable-rate mortgage (ARM), sometimes called a variable-rate mortgage or tracker mortgage, is a home loan that may have periodic changes to the interest rate. These types of mortgages often feature a “teaser rate,” a low fixed rate for some portion of the loan at the beginning before the adjustment period begins.
One of the most common examples of an adjustable-rate mortgage is what is known as the 5/1 ARM. In this mortgage, the rate will remain flat for the first five years of the loan, but after that the lender has the ability to adjust the rate annually based on current market costs.
ARM loans are most commonly used by buyers who do not plan to stay in their homes for a long time. For example, if a newly-married couple is looking for an affordable option for a couple of years but knows that they will likely need to move into a larger space as their family grows, they may consider taking out an ARM loan to take advantage of the lower rate early on. However, they may sacrifice equity by moving from one home to the next so quickly, and they may also be responsible for closing costs on one or both mortgages.
3: FHA Mortgage
An FHA mortgage is a government-backed loan insured by the US Federal Housing Administration. These types of loans can only be made by FHA approved lenders and have fewer restrictions placed on borrowers compared to other loan types. FHA loans may be offered as 15- or 30-year fixed-rate mortgages or as ARM loans.
Qualifying for an FHA loan is generally fairly easy, and they often require down payments as low as 3.5%. These loans are for smaller amounts than conventional mortgages and require mortgage insurance premiums. FHA mortgages are generally the best option for borrowers who have lower credit scores and can’t afford to put down the 20% required for fixed-rate mortgages.
4: VA Mortgage
A Veterans Administration (VA) mortgage is another government-back loan that is insured by the Department of Veterans Affairs. These types of loans are only available through VA approved lenders for qualified military service members and veterans. The VA does not require a minimum credit score to qualify; however, the lender may choose additional borrower requirements.
Despite a required VA funding fee, VA mortgage payments are generally lower because they have no down payment or mortgage insurance requirements. Because of this, VA mortgages are considered by many to be one of the greatest rewards for military personnel.
5: USDA Mortgage
A USDA mortgage, offered through the United States Department of Agriculture’s Rural Development Guaranteed Housing Loan Program, is another government-backed loan. These types of home mortgages offer a no-down-payment loan, but are only eligible in certain qualifying rural or suburban areas.
USDA mortgages generally mean more lenient requirements for borrowers as well as lower interest rates and monthly fees. However, they do require upfront guarantee fees and have an annual fee. They are also only available to specific areas and subject to limits on income and property value. These mortgages are popular with homebuyers in rural areas who aren’t able to make a large down payment.
6: Jumbo Mortgage
A jumbo mortgage is a non-conforming loan because it exceeds the limit set by the Federal Housing Financing Agency (FHFA). These loans are also non-conventional because they cannot be purchased or guaranteed by Fannie Mae or Freddie Mac. What qualifies as a jumbo loan can vary by county, and the FHFA updates these numbers. These loans are often used to buy high-end or luxury properties and come with their own unique lending requirements based on the lender.
To qualify for a jumbo mortgage, a borrower needs a high credit score, high cash reserves, and a high income. Jumbo mortgages usually require a down payment of 10% or more and will have higher closing costs than other mortgages because of the higher loan amounts. These loans may be offered as either fixed- or adjustable-rate mortgages.
7: Balloon Mortgage
Lenders structure balloon mortgages to have the borrower make interest-only payments each month until the end of the loan term, at which time the full balance is due in a final lump sum. They’re common in commercial real estate and often end in the borrower refinancing the mortgage before the payment comes due. Balloon mortgages also tend to be short, typically lasting only five to seven years.
There are occasions where a homebuyer might select a balloon mortgage because they don’t expect to stay in their home very long. However, they would not build equity in the home and may not be better off than if they had rented.
8: Bridge Mortgage
Current homeowners looking to finance a new property can use use their current home as collateral with a bridge loan. These are short-term loans that typically last a year or less, but they can also put the borrower in a position to pay two mortgages concurrently. However, payments can be interest-only until the original property is sold, so the expense of taking on a bridge loan may not be quite as daunting as some alternatives.
Homeowners frequently use bridge loans to transition between homes. Those who want to finance the purchase of a new home while they wait for their current home to sell may consider a bridge loan. This can also give the borrower the ability to make an offer on a new home without the need for a selling contingency.
Refinancing to Change Your Mortgage Loan Type
While much of the information above may sound specific to borrowers looking to purchase a home, one of the great benefits of refinancing a mortgage is that it can allow a homeowner to change their mortgage type. As circumstances change, whether they be personal finances, conditions in the local market, or something else entirely, changing your mortgage loan type can help you work toward a more secure financial future.
Find Out What Your Options Are
Whether you are looking to buy a home or refinance an existing mortgage, we want to help you make the right decision. Our team is here to walk through the home buying process with you. Let's start by assessing your current situation and discussing what type of mortgage you qualify for. To get started, fill out the form below and one of our friendly, knowledgeable loan advisors will contact you.