Understanding Different Types of Home Loans
3 min read
Mortgages are a popular method of financing the purchase of real estate. Like other loans, mortgages require the borrower to meet certain requirements and pay a loan principal, interest rate and closing costs.
Choosing the right mortgage for your home buying needs can be confusing. This guide will help you understand the various types of mortgages and their pros and cons.
Fixed-Rate Loans
One of the most basic types of home loans are fixed-rate mortgages. As the name suggests, fixed-rate loans have an interest rate that stays the same throughout the life of the loan. Unlike adjustable-rate mortgages (ARMs), which have an initial introductory period, the fixed-rate loan’s interest rate won’t change during the term.
This type of loan offers borrowers predictable monthly payments, which can help them better budget for their homes. Additionally, fixed-rate loans provide a level of stability and predictability that may be beneficial for those who are saving for retirement or starting families.
Borrowers can find out how much their monthly mortgage payments will be by using a home loan calculator. These tools typically take into account a borrower’s home price, down payment, loan terms, and interest rate to calculate the monthly mortgage payments. Many of these calculators also break down the monthly payments to show how much goes toward principal and interest, and some even include property taxes.
Adjustable-Rate Loans
Adjustable-rate mortgages (ARMs) have interest rates that change over the life of the loan based on market conditions. ARMs typically come with an initial fixed period that lasts from 1 to 10 years, followed by an adjustable-rate phase. During the fixed-rate period, you’ll pay an introductory rate that’s usually lower than a conventional 30-year fixed-rate loan.
During the adjustable-rate period, your rate will rise or fall depending on market rates at specific intervals determined by your lender. Generally, ARMs have caps on how much your rate can increase or decrease per adjustment period and over the lifetime of the loan.
While ARMs may seem appealing because they offer lower interest rates than traditional home loans, they also carry greater risk and may not be suitable for every borrower. Before choosing an ARM, it’s important to consider worst-case scenarios and determine whether you can afford your monthly payment increases in various economic situations. You can use a tool like Investopedia’s mortgage calculator to help calculate your payments for each scenario.
Government-Insured Loans
Government-insured loans (or government-backed mortgages) are a type of mortgage loan that is insured or guaranteed by the federal government. The federal government has several mortgage insurance programs, including those of the FHA, USDA, and VA.
Because the government backs these types of mortgages, they allow lenders to offer more lenient guidelines for credit scores and debt-to-income ratios. This allows borrowers to access homeownership who may not qualify for conventional mortgages, opening doors that would otherwise remain closed.
The requirements of government-backed mortgages vary, but they typically require a lower down payment than conventional loans – with FHA mortgages requiring as little as 3.5% down and VA and USDA loans offering no down payment at all. However, they may also require higher mortgage insurance payments than a conventional loan. This is because conventional mortgages are not insured or guaranteed by the federal government. They are instead guaranteed by the housing government-sponsored enterprises Fannie Mae and Freddie Mac, which have their own requirements.
Conventional Loans
Conventional loans are mortgages that aren’t backed by any type of government entity, such as the FHA or USDA. Conventional loans are typically available to homebuyers with a credit score of at least 620 and can have loan terms that range from 15 years to 30 years. These mortgages often require a down payment of up to 20% and may include fees such as the origination fee, appraisal fee and mortgage insurance.
Borrowers can obtain conventional mortgages through their bank, credit union, savings and loan association or mortgage lender. They also are available through mortgage brokers.
Conventional lenders set their own qualification requirements, but most have guidelines similar to those of Fannie Mae and Freddie Mac. These guidelines include minimum down payment requirements, credit and income requirements and a maximum loan limit. First-time and repeat homebuyers can generally qualify for conventional mortgages. If you have strong finances and meet the criteria, this is one of the best home loan options available.
